“One more dawn
One more day
One day more!”
-Les Miserables (music by Claude-Michel Schönberg, lyrics by Herbert Kretzmer and Alain Boublil)
I could not get this song out of my head over the weekend. If you have seen “Les Miserables”, and at this point, I am not sure who has not seen it, you know that throughout the song, the music swells and the action is packed, as the revolution approaches in France and intermission is upon the theater-goers. Well, I am hopeful that there will be no revolution on the horizon, but I am truly looking forward to the end of this year and the beginning of a new one.
2007 has been a wild ride. We should have known from the February swoon that the year would shape up far differently than the preceding one. From the worries about US housing, to the subprime fiasco and the associated financial losses that resulted from the credit crunch and the predictions about recession, I think that investors are flat-out exhausted. In fact, to come through a year like this one and still be able to make money in your retirement and investment accounts feels like a major victory!
As we close the book on 2007, there are some major lessons that you will need to bring with you as you enter 2008. As my father always told me, one of the keys of becoming a seasoned investor is to learn from both the market as a whole and your mistakes in particular. Here are some good nuggets from 2007 to contemplate before turning the page of your calendar to January.
1) Housing values can drop. Gone are the folks who claimed that “real estate never goes down!” 2007 cured anyone of that simple notion.
2) Credit crunches last longer than expected. When we first started to hear about “sub-prime” and “Alt-A” loans, they seemed to be self-contained issues. Clearly, that was not the case.
3) Corporate Execs can be accountable. After the dot-com bubble burst, few CEO’s stood up and took the blame. Both E. Stan O’Neal (Merrill Lynch) and Chuck Prince (Citigroup) not only accepted responsibility directly, they also lost their jobs in the process.
4) The Fed rules. The entire year was spent guessing what the Federal Reserve might do to alleviate the housing recession and the credit crunch. Each time investors thought they knew what would happen, Ben Bernanke and Co. veered in a different direction. Our 2008 wish for the central bankers is that they better coordinate policy action with their interim speeches.
5) Risk matters. When markets rise for long periods of time, investors can become complacent. 2007 forced investors to confront market volatility and the gut checks that resulted from the violent swings allowed many to better understand their personal risk tolerance. Of all of the lessons, this is the most practical one: be honest with yourself about risk and allocate your portfolio accordingly.
With one more day to go, those are just a few of the pearls of wisdom gleaned from 2007. As you look back on the year in your rear-view mirror, you are likely to find many more examples to bring into 2008. Luckily, we all have a day to rest before we start all over again.
HAPPY NEW YEAR!
Monday, December 31, 2007
Friday, December 28, 2007
Investing in a Messy World
As I read the early news reports about how the former Pakistani Prime Minister Benazir Bhutto was killed in an apparent suicide attack in the military garrison town of Rawalpindi, I was sickened. The news and subsequent images were shocking and disturbing, but the event was also a good reminder that not only do we live in a dangerous world, but as investors, we are constantly reminded that this messy world should be factored into our outlook.
As soon as the story hit the wires, stocks began to sell off. Clearly this was not as dramatic as the terrorist attacks of 9-11, or the subsequent terrorist bombings in Spain or London (all of which markets recovered from in fairly quick order). But the Bhutto murder clearly created an impact, especially in light of a light-volume, holiday-shortened week. Before the news hit the wires, stocks were pointing higher, but when the details of the story emerged, stock futures turned lower and continued to decline throughout the trading day.
I happened to be a guest on Fox Business News yesterday and one guest noted that Pakistan is not a particularly large US trading partner and has absolutely nothing to do with oil production. True enough, but it is a nuclear power and when video of riots there hit our airwaves, most people worried, “Who is in control over there?” The Pakistani turmoil reminds us of our dangerous world, which calls into question the safety of all of our investment assumptions and causes general anxiety. Clearly uncertainty is the enemy of investors. As more details emerged, investors sought safe havens like US Treasury-bonds and physical assets, like gold, both of which gained ground.
Perhaps when a senseless event occurs that throws the world and markets into a chaotic state, it is the best reminder that investors can only control so much. We do not know when the housing slump will end; when a corporate scandal might erupt; or when a geopolitical crisis will cripple some part of the world where the US has a significant interest. For that reason, it is imperative that investors maintain a disciplined approach to risk and create diversified portfolios that help weather the gyrations associated with investing in a messy world.
As soon as the story hit the wires, stocks began to sell off. Clearly this was not as dramatic as the terrorist attacks of 9-11, or the subsequent terrorist bombings in Spain or London (all of which markets recovered from in fairly quick order). But the Bhutto murder clearly created an impact, especially in light of a light-volume, holiday-shortened week. Before the news hit the wires, stocks were pointing higher, but when the details of the story emerged, stock futures turned lower and continued to decline throughout the trading day.
I happened to be a guest on Fox Business News yesterday and one guest noted that Pakistan is not a particularly large US trading partner and has absolutely nothing to do with oil production. True enough, but it is a nuclear power and when video of riots there hit our airwaves, most people worried, “Who is in control over there?” The Pakistani turmoil reminds us of our dangerous world, which calls into question the safety of all of our investment assumptions and causes general anxiety. Clearly uncertainty is the enemy of investors. As more details emerged, investors sought safe havens like US Treasury-bonds and physical assets, like gold, both of which gained ground.
Perhaps when a senseless event occurs that throws the world and markets into a chaotic state, it is the best reminder that investors can only control so much. We do not know when the housing slump will end; when a corporate scandal might erupt; or when a geopolitical crisis will cripple some part of the world where the US has a significant interest. For that reason, it is imperative that investors maintain a disciplined approach to risk and create diversified portfolios that help weather the gyrations associated with investing in a messy world.
Thursday, December 27, 2007
The Christmas of Small Pleasures
By now you know that this holiday season was not among the best for the nation’s retailers. Although the final results are not yet in, an early projection from MasterCard Advisors, a unit of the credit card company, found that overall spending from Nov. 23 to Dec. 24, when adjusted for inflation, was essentially unchanged over last year -- a weak performance. In many ways, the holiday season is a good metaphor for 2007: the year of reduced expectations and small pleasures.
I keep thinking that despite 2007 being the Chinese Year of the Pig, the year will be remembered more for small indulgences than big ones. In terms of financial stories, the subprime issue grabbed pig-like headlines, but for investors, the housing recession and credit woes got everyone refocused on single-digit investment returns, which frankly, were greatly appreciated, especially considering the alternatives!
On the holiday front, it is obvious that there was no big, “must-have” item either for kids or adults. But somehow, we found delight in some tried and true items: new video games; Apple i-products; and perhaps the strangest category, women’s shoes. While I doubt that most people gave a pair of Jimmy Choo’s or Manolo Blahnik’s to their gal-pals, perhaps a quick, guilty indulgence made its way into our bargain-hunting holiday season.
In entertainment, there was no big movie that blew away expectations, but a few small ones were notable. I loved my friend Adrienne Shelly’s “Waitress” (she wrote and directed the movie before she was murdered in New York City in November, 2006) and if you want a real holiday treat this season, skip the tiresome formulaic pics like “National Treasure” and go directly to “Juno” a quirky film written by first-time writer Diablo Cody and directed Jason Reitman. Meanwhile, on the small screen, the simple pleasure of NBC’s “Friday Night Lights” and “30 Rock” can’t be beat.
But here is the absolute coolest thing about the year and Christmas of Small Pleasures: it hopefully made us all realize just how lucky we are to have so much. As thousands of servicemen and women are stationed overseas in harm’s way, I can’t help but think about the great fortune that we as American citizens enjoy. Next year is likely to be a big year, filled with election-year politics and plenty of vitriol. Try not to forget what a blessing it is to live in a society where we each are given the opportunity to express ourselves -- now that’s a great big gift that we receive each and every year, but rarely take time to appreciate.
I keep thinking that despite 2007 being the Chinese Year of the Pig, the year will be remembered more for small indulgences than big ones. In terms of financial stories, the subprime issue grabbed pig-like headlines, but for investors, the housing recession and credit woes got everyone refocused on single-digit investment returns, which frankly, were greatly appreciated, especially considering the alternatives!
On the holiday front, it is obvious that there was no big, “must-have” item either for kids or adults. But somehow, we found delight in some tried and true items: new video games; Apple i-products; and perhaps the strangest category, women’s shoes. While I doubt that most people gave a pair of Jimmy Choo’s or Manolo Blahnik’s to their gal-pals, perhaps a quick, guilty indulgence made its way into our bargain-hunting holiday season.
In entertainment, there was no big movie that blew away expectations, but a few small ones were notable. I loved my friend Adrienne Shelly’s “Waitress” (she wrote and directed the movie before she was murdered in New York City in November, 2006) and if you want a real holiday treat this season, skip the tiresome formulaic pics like “National Treasure” and go directly to “Juno” a quirky film written by first-time writer Diablo Cody and directed Jason Reitman. Meanwhile, on the small screen, the simple pleasure of NBC’s “Friday Night Lights” and “30 Rock” can’t be beat.
But here is the absolute coolest thing about the year and Christmas of Small Pleasures: it hopefully made us all realize just how lucky we are to have so much. As thousands of servicemen and women are stationed overseas in harm’s way, I can’t help but think about the great fortune that we as American citizens enjoy. Next year is likely to be a big year, filled with election-year politics and plenty of vitriol. Try not to forget what a blessing it is to live in a society where we each are given the opportunity to express ourselves -- now that’s a great big gift that we receive each and every year, but rarely take time to appreciate.
Monday, December 24, 2007
A Few of My Favorite Christmas Things…
No money talk on Christmas Eve day---it just seems a bit too crass! It took me a long time to really get into Christmas. I grew up in a Jewish (although not religious) family and although my mother absolutely adores Christmas trees and knows more words to carols than most gentile folks, we pretty much did the “Jewish thing” around Christmas. We did not go near the maddening crowds in the stores and on the day itself, we headed to the movies, followed by a feast at the local Chinese restaurant.
But when I moved to Rhode Island, my friend Joyce introduced me to her family’s Christmas tradition. I fell in love with it—from decorating the tree, to the countless meals involved. They are Italians from Brooklyn, NY so the major thrust of the holiday centered around fish Christmas Eve and the hand-made ravioli on Christmas Day. When I began to split my time between New York and New England, I found a New York-based Italian family to not only take me, but allow me to become part of their rituals.
In a nod to the season, it’s time to recount some of my favorite Christmas things. The list continues to grow, but here is where I am so far:
1) Selecting, schlepping and decorating the tree: Each year, I now purchase a new ornament that has some special meaning for me. Now if I could only untangle the lights!
2) Shopping: The true meaning of Christmas has nothing to do with presents, but I can’t help but throw my self into the gift-buying rat race. I love how beautiful the stores look and I am often amused by the frenzy that surrounds the season.
3) The tree in Rockefeller Center: I walk by the tree as often as possible to look at its beauty and towering glory. If you get a chance, check out the new GE (what else?) lights.
4) Christmas Day and Marie’s lasagna: By the time we have finished the appetizers, I am usually stuffed, but not too much to indulge in the most magnificent lasagna I have ever tasted. The turkey/ham that follows is a sideshow to the main attraction.
5) “A Charlie Brown Christmas”: The best Christmas TV program or movie, which happened to premier on my exact birthday. I love Linus’ soliloquy about the true meaning of Christmas.
6) Christmas Music: Mary Ann in my office asked someone whether it was OK to play holiday music on our system at work, “because I know that Jill is Jewish”. The response was, “Jill LOVES it!” My favorite is probably Bing Crosby’s original recording of “White Christmas.”
Take it from this nice Jewish girl, you do not have to be religious to enjoy this special season. I hope that it finds you and your families gathered together and celebrating the gifts that have been bestowed on you. MERRY CHRISTMAS!!!
But when I moved to Rhode Island, my friend Joyce introduced me to her family’s Christmas tradition. I fell in love with it—from decorating the tree, to the countless meals involved. They are Italians from Brooklyn, NY so the major thrust of the holiday centered around fish Christmas Eve and the hand-made ravioli on Christmas Day. When I began to split my time between New York and New England, I found a New York-based Italian family to not only take me, but allow me to become part of their rituals.
In a nod to the season, it’s time to recount some of my favorite Christmas things. The list continues to grow, but here is where I am so far:
1) Selecting, schlepping and decorating the tree: Each year, I now purchase a new ornament that has some special meaning for me. Now if I could only untangle the lights!
2) Shopping: The true meaning of Christmas has nothing to do with presents, but I can’t help but throw my self into the gift-buying rat race. I love how beautiful the stores look and I am often amused by the frenzy that surrounds the season.
3) The tree in Rockefeller Center: I walk by the tree as often as possible to look at its beauty and towering glory. If you get a chance, check out the new GE (what else?) lights.
4) Christmas Day and Marie’s lasagna: By the time we have finished the appetizers, I am usually stuffed, but not too much to indulge in the most magnificent lasagna I have ever tasted. The turkey/ham that follows is a sideshow to the main attraction.
5) “A Charlie Brown Christmas”: The best Christmas TV program or movie, which happened to premier on my exact birthday. I love Linus’ soliloquy about the true meaning of Christmas.
6) Christmas Music: Mary Ann in my office asked someone whether it was OK to play holiday music on our system at work, “because I know that Jill is Jewish”. The response was, “Jill LOVES it!” My favorite is probably Bing Crosby’s original recording of “White Christmas.”
Take it from this nice Jewish girl, you do not have to be religious to enjoy this special season. I hope that it finds you and your families gathered together and celebrating the gifts that have been bestowed on you. MERRY CHRISTMAS!!!
Friday, December 21, 2007
The Mute Button
Take it from one who has often inserted one of her size nine feet in her mouth: when it comes to office etiquette, these times demand the utmost of vigilance. Even your unintended, harmless misstep can end up in places that you never dreamed possible. As the year draws to a close and the news is light, today is a reminder of a few handy tips to help you beef up your office etiquette and decision-making abilities.
1) Read and re-read your e-mail body and address line before you hit the send button: I learned this lesson early in the e-mail era. A man who had no intention of working with the firm peppered me with about a million questions and one day, I was so fed up, I forwarded his message to someone in my office, calling the serial questioner a “leach”. Check that…I thought that I had forwarded the message, when in fact I erroneously hit the reply button. As you might imagine, the leach moniker did not go over very well.
2) Beware of the Mute button: Years ago, my investment banking sister was on a conference call when her boss pushed the mute button and said to the roomful of people, “These guys (on the other side of the deal and the phone line) are such idiots. After we close, I hope that I never have to talk to them again.” Imagine his surprise when from the other end of the line, he heard: “believe me, the feeling is mutual!” Mute buttons are tricky – my advice is to never say anything negative while on a call, mute button or not.
3) When you run a public company, try not to curse at analysts and definitely lose the sarcasm: You might think that this is silly advice, but on Wednesday, Sallie Mae’s chief executive Albert L. Lord conducted what could only be called a disastrous call. Clearly the company has gone through some pretty serious troubles, but Lord preferred to avoid the questions and said that he would answer them at a meeting in January.
Folks were not too happy with the evasion, so in a bit of (failed) sarcasm, Lord said: "I can assure you, you will be going through a metal detector." Get it? He was joking about a disgruntled investor storming the shareholder meeting with a gun. Not funny. Well, at least Lord ended the conference call with a bang. He said "Let's go. There's no questions. Let's get the [expletive] out of here." That line ended up on countless blogs almost immediately and is now part of the permanent history of Mr. Lord’s tenure at the firm.
4) Take “The Mirror Test”: The fine team at the Illinois-based Ethical Leadership Group has developed what they call “The Mirror Test” for every professional. Before you do/say/send anything, ask yourself the following three questions, which should help you avoid hot water:
1) Is it Legal?
2) Is it Right?
3) What will Others Think?
This simple process can truly recalibrate your decision-making process and hopefully will help you think through your actions and words before you insert your foot in your mouth!
1) Read and re-read your e-mail body and address line before you hit the send button: I learned this lesson early in the e-mail era. A man who had no intention of working with the firm peppered me with about a million questions and one day, I was so fed up, I forwarded his message to someone in my office, calling the serial questioner a “leach”. Check that…I thought that I had forwarded the message, when in fact I erroneously hit the reply button. As you might imagine, the leach moniker did not go over very well.
2) Beware of the Mute button: Years ago, my investment banking sister was on a conference call when her boss pushed the mute button and said to the roomful of people, “These guys (on the other side of the deal and the phone line) are such idiots. After we close, I hope that I never have to talk to them again.” Imagine his surprise when from the other end of the line, he heard: “believe me, the feeling is mutual!” Mute buttons are tricky – my advice is to never say anything negative while on a call, mute button or not.
3) When you run a public company, try not to curse at analysts and definitely lose the sarcasm: You might think that this is silly advice, but on Wednesday, Sallie Mae’s chief executive Albert L. Lord conducted what could only be called a disastrous call. Clearly the company has gone through some pretty serious troubles, but Lord preferred to avoid the questions and said that he would answer them at a meeting in January.
Folks were not too happy with the evasion, so in a bit of (failed) sarcasm, Lord said: "I can assure you, you will be going through a metal detector." Get it? He was joking about a disgruntled investor storming the shareholder meeting with a gun. Not funny. Well, at least Lord ended the conference call with a bang. He said "Let's go. There's no questions. Let's get the [expletive] out of here." That line ended up on countless blogs almost immediately and is now part of the permanent history of Mr. Lord’s tenure at the firm.
4) Take “The Mirror Test”: The fine team at the Illinois-based Ethical Leadership Group has developed what they call “The Mirror Test” for every professional. Before you do/say/send anything, ask yourself the following three questions, which should help you avoid hot water:
1) Is it Legal?
2) Is it Right?
3) What will Others Think?
This simple process can truly recalibrate your decision-making process and hopefully will help you think through your actions and words before you insert your foot in your mouth!
Thursday, December 20, 2007
Bonus Bust
It seems like just a year ago that Wall Street executives were patting themselves on the back for another stellar year. The total 2006 bonuses for the C-Suite could feed many third world nations and yet a scant year later, the landscape has shifted. Yesterday, the bosses of two major firms announced that bonuses would total the big goose egg.
Bear Stearns, the firm that will likely be remembered as the “tip of the 2007 subprime iceberg” said that its Chief Executive Officer James Cayne and other senior executives would forgo bonuses for this year. This is probably a pretty good idea, especially when the firm is expected to announce its first quarterly loss ever. Across town, the folks at Morgan Stanley announced some news of its own, some bad, and some less-bad.
Morgan Stanley's first-ever quarterly loss was highlighted by a $9.4 billion write-down related to mortgages. But it also said that it was shoring up its capital with a $5 billion investment from China's sovereign wealth fund. Like Jimmy Cayne, Morgan Stanley CEO John Mack will take a pass on a year-end bonus this year. But don’t feel too bad for him—he’ll probably figure out a way to stretch last year’s $40 million bonus to help his personal cash flow withstand the sagging the value of his stock, down over 25% year-to-date heading into the day yesterday.
CEO bonuses notwithstanding, total compensation at Morgan Stanley, including salaries, benefits and bonuses, climbed 18% to $16.55 billion in 2007 from $13.99 billion last year. Year-end bonuses, estimated at about 60% of the total comp, will jump to $9.93 billion from $8.39 billion. In a weird way, it makes sense. After all, the guys in the profitable units---equities, investment banking and wealth management---saved the firm from even worse performance.
When all is said and done, folks in this industry get paid a whole lot of money in both the good years and the bad ones. Yes, it’s obscene, because they are not saving lives, teaching the youth of America or finding a cure for cancer. But still, I for one appreciate when the guys at the top acknowledge that they bear responsibility for the decisions that led to the bad year and accordingly, should not be sucking money out of the company. Now if they can get those risk management departments in line, we may see the other side of this nastiness.
Bear Stearns, the firm that will likely be remembered as the “tip of the 2007 subprime iceberg” said that its Chief Executive Officer James Cayne and other senior executives would forgo bonuses for this year. This is probably a pretty good idea, especially when the firm is expected to announce its first quarterly loss ever. Across town, the folks at Morgan Stanley announced some news of its own, some bad, and some less-bad.
Morgan Stanley's first-ever quarterly loss was highlighted by a $9.4 billion write-down related to mortgages. But it also said that it was shoring up its capital with a $5 billion investment from China's sovereign wealth fund. Like Jimmy Cayne, Morgan Stanley CEO John Mack will take a pass on a year-end bonus this year. But don’t feel too bad for him—he’ll probably figure out a way to stretch last year’s $40 million bonus to help his personal cash flow withstand the sagging the value of his stock, down over 25% year-to-date heading into the day yesterday.
CEO bonuses notwithstanding, total compensation at Morgan Stanley, including salaries, benefits and bonuses, climbed 18% to $16.55 billion in 2007 from $13.99 billion last year. Year-end bonuses, estimated at about 60% of the total comp, will jump to $9.93 billion from $8.39 billion. In a weird way, it makes sense. After all, the guys in the profitable units---equities, investment banking and wealth management---saved the firm from even worse performance.
When all is said and done, folks in this industry get paid a whole lot of money in both the good years and the bad ones. Yes, it’s obscene, because they are not saving lives, teaching the youth of America or finding a cure for cancer. But still, I for one appreciate when the guys at the top acknowledge that they bear responsibility for the decisions that led to the bad year and accordingly, should not be sucking money out of the company. Now if they can get those risk management departments in line, we may see the other side of this nastiness.
Tuesday, December 18, 2007
Holiday Cheer Part 3
Today is the final of our three-part year-end financial countdown—we started with using taxable accounts to harvest tax losses; then went to maximizing retirement plans to save taxes and get on track with retirement goals and objectives. Today it’s time to find the real spirit of the holidays and discuss charitable giving.
According to a report published by the Giving USA Foundation, a nonprofit group that supports research and education in philanthropy, U.S. donors gave $295 billion directly to charitable causes last year, up 4.2% from 2005. It’s not just the super-wealthy who dig into their pockets--about 65% of households with incomes of less than $100,000 gave to charity last year, with the average American giving 2% of income and the wealthiest as much as 8% to 10%, the report found.
Most people do not give unless they truly want to give. That being said, Uncle Sam provides some encouragement to those who do make charitable donations. If you are gifting to a non-profit, consider donating appreciated securities in lieu of cash. By giving away stock -- instead of selling it and donating the cash -- you can claim deductions against your federal income taxes for the current market value of shares, and avoid paying capital-gains tax on the appreciation. Most large non-profits can accept stock directly. For a smaller charity that isn't equipped to take stock, contributions can be made through a donor-advised fund or foundation. But don’t wait until New Year's Eve to make stock contributions if you want to include them in your 2007 tax returns --- stock transfers can take weeks.
In addition to gifting stock, an interesting opportunity lies in your IRA account. Consider taking advantage of a law scheduled to expire at the end of this month that could benefit many taxpayers who are over 70½. If you qualify, you can transfer as much as $100,000 this year directly from your individual retirement account to a qualified charity without having to pay income taxes on that money. Also, the transfer counts toward your minimum required distribution for the year. Just make sure the gift is made directly from the IRA to charity. Taxpayers should take advantage of this break this year because it could vanish.
There is one other gifting idea that is set to expire at the end of 2007: the Kiddie Tax Rule. The Kiddie Tax is an obscure tax designed to keep the wealthy from transferring money to their children, who would in turn pay taxes at the child’s, not the parent’s, rate. Those of you with custodial accounts might find that recent changes to the rules result in an increase in taxes in 2008. The good news: there is a window of opportunity between now and the end of the year where you might be able to save on capital gains taxation, if you sell certain assets in 2007.
Here is how it works: For a child subject to the Kiddie Tax, any unearned income (interest, dividends and capital gains) received in 2007 is first exempted from taxation, then taxed at the child’s rate, and finally taxed at the parent’s rate, as indicated in the table below.
Taxation of Child’s Unearned Income 2007
Up to $850* Exempt from taxation
$851 to $1700 Taxed at the child’s rate
Over $1700 Taxed at the parent’s rate
*All figures indexed annually for inflation
Currently the Kiddie Tax impacts children who are under 18. Beginning in 2008, however, dependent children who are 18 will also be subject to the tax as well as dependent full-time students between the ages of 19 and 23. While the rules primarily affect UTMA and UGMA (Custodial) accounts, they can also apply to a child’s individual account once the UTMA/UGMA has been distributed, and to 2503(b) trusts, assuming the child is still claimed as a dependent on your tax returns.
For those who have UTMA accounts, or dependent children with individual accounts, and whose children/students are between the ages of 18 and 22 this year, there is a one time opportunity to sell appreciated assets in order to take advantage of the child’s 2007 5% capital gains rate (up to a child’s taxable income of $31,850). This particularly applies to assets which are earmarked for college and which should be sold in the next few years to pay for tuition costs. The capital gains rate will increase to 15% in 2008 on unearned income above the Kiddie Tax limit. Interest and dividends count too, although most custodial and individual accounts are not large enough to generate sufficient earnings to be taxed at the parent’s rate.
Finally, it’s worth noting that the annual gift tax exclusion permits individuals to give up to $12,000 to an unlimited number of individuals during the calendar year ($24,000 if you are married and gift-splitting is elected), so if you plan to make gift, get going now!
According to a report published by the Giving USA Foundation, a nonprofit group that supports research and education in philanthropy, U.S. donors gave $295 billion directly to charitable causes last year, up 4.2% from 2005. It’s not just the super-wealthy who dig into their pockets--about 65% of households with incomes of less than $100,000 gave to charity last year, with the average American giving 2% of income and the wealthiest as much as 8% to 10%, the report found.
Most people do not give unless they truly want to give. That being said, Uncle Sam provides some encouragement to those who do make charitable donations. If you are gifting to a non-profit, consider donating appreciated securities in lieu of cash. By giving away stock -- instead of selling it and donating the cash -- you can claim deductions against your federal income taxes for the current market value of shares, and avoid paying capital-gains tax on the appreciation. Most large non-profits can accept stock directly. For a smaller charity that isn't equipped to take stock, contributions can be made through a donor-advised fund or foundation. But don’t wait until New Year's Eve to make stock contributions if you want to include them in your 2007 tax returns --- stock transfers can take weeks.
In addition to gifting stock, an interesting opportunity lies in your IRA account. Consider taking advantage of a law scheduled to expire at the end of this month that could benefit many taxpayers who are over 70½. If you qualify, you can transfer as much as $100,000 this year directly from your individual retirement account to a qualified charity without having to pay income taxes on that money. Also, the transfer counts toward your minimum required distribution for the year. Just make sure the gift is made directly from the IRA to charity. Taxpayers should take advantage of this break this year because it could vanish.
There is one other gifting idea that is set to expire at the end of 2007: the Kiddie Tax Rule. The Kiddie Tax is an obscure tax designed to keep the wealthy from transferring money to their children, who would in turn pay taxes at the child’s, not the parent’s, rate. Those of you with custodial accounts might find that recent changes to the rules result in an increase in taxes in 2008. The good news: there is a window of opportunity between now and the end of the year where you might be able to save on capital gains taxation, if you sell certain assets in 2007.
Here is how it works: For a child subject to the Kiddie Tax, any unearned income (interest, dividends and capital gains) received in 2007 is first exempted from taxation, then taxed at the child’s rate, and finally taxed at the parent’s rate, as indicated in the table below.
Taxation of Child’s Unearned Income 2007
Up to $850* Exempt from taxation
$851 to $1700 Taxed at the child’s rate
Over $1700 Taxed at the parent’s rate
*All figures indexed annually for inflation
Currently the Kiddie Tax impacts children who are under 18. Beginning in 2008, however, dependent children who are 18 will also be subject to the tax as well as dependent full-time students between the ages of 19 and 23. While the rules primarily affect UTMA and UGMA (Custodial) accounts, they can also apply to a child’s individual account once the UTMA/UGMA has been distributed, and to 2503(b) trusts, assuming the child is still claimed as a dependent on your tax returns.
For those who have UTMA accounts, or dependent children with individual accounts, and whose children/students are between the ages of 18 and 22 this year, there is a one time opportunity to sell appreciated assets in order to take advantage of the child’s 2007 5% capital gains rate (up to a child’s taxable income of $31,850). This particularly applies to assets which are earmarked for college and which should be sold in the next few years to pay for tuition costs. The capital gains rate will increase to 15% in 2008 on unearned income above the Kiddie Tax limit. Interest and dividends count too, although most custodial and individual accounts are not large enough to generate sufficient earnings to be taxed at the parent’s rate.
Finally, it’s worth noting that the annual gift tax exclusion permits individuals to give up to $12,000 to an unlimited number of individuals during the calendar year ($24,000 if you are married and gift-splitting is elected), so if you plan to make gift, get going now!
Monday, December 17, 2007
Can’t Lose on a house
For years, I have met with folks who are hyper-focused on purchasing a house as the major financial goal in their lives. They say things like, “renting is like throwing money out of the window”, “real estate is better than the stock market as an investment” and my favorite, “I know that I can’t lose on a house.” To all of these comments, I have been known to say a not-very mature response: “OH YEAH?”
I have always been a bit more agnostic about owning vs. renting. For some, renting is a perfect solution to providing shelter. In fact, my guess is that if many of the people who purchased over the past two years had just stayed put in their affordable rentals, the real estate market might not be in the pickle it is in. That being said, I know that it’s easy to get lured into becoming a buyer by that nagging voice, which goes something like this: “my principal, interest and homeowners insurance would be the same as my rent, so why not buy the house and start building equity?”
Because gentle reader, your payments will not stop with your principal, interest and homeowners insurance. Even if you put down 20% and finance your mortgage with a fixed rate, there are so many more costs associated with home ownership, that the comparison may not be quite as good as you think. In fact, if you invest what would have been your down payment, the whole “throwing money out of the window” argument goes…well, out the window.
As far as the “I can’t lose on a house” thesis, well it’s just not true. Currently, house prices are down by 0.5% to 10%, depending on the measure used and are expected to fall further before we are done with the process. Of course if you hold a house over the long term, it should beat the inflation rate, but so too should the stock market. Like the stock market, real estate can in fact go through corrective periods, but thankfully, most people are not tempted and/or forced to sell at these low points. Since World War II, housing prices have lagged the performance of the stock market, but it just does not seem that way, because few people adjust the value of their homes for inflation—instead they say: I bought this house in 1965 for $40,000 and today it’s worth $400,000!”
I know that the notion of home ownership is engrained in our society—so much so that Uncle Sam helps you out with a mortgage interest deduction. But to quote economist Robert Shiller: “maybe we’ve gone too far in that only so many people can comfortably own homes, and it became an excuse for extravagant lending…Most people think home prices can’t fall for very long. The fact they haven’t since the Great Depression in a massive way is proof to many people … that they can’t fall. And I think the people are lacking the historical perspective that big events might come 70 years apart. And there’s remarkably little interest in historical episodes.”
I have always been a bit more agnostic about owning vs. renting. For some, renting is a perfect solution to providing shelter. In fact, my guess is that if many of the people who purchased over the past two years had just stayed put in their affordable rentals, the real estate market might not be in the pickle it is in. That being said, I know that it’s easy to get lured into becoming a buyer by that nagging voice, which goes something like this: “my principal, interest and homeowners insurance would be the same as my rent, so why not buy the house and start building equity?”
Because gentle reader, your payments will not stop with your principal, interest and homeowners insurance. Even if you put down 20% and finance your mortgage with a fixed rate, there are so many more costs associated with home ownership, that the comparison may not be quite as good as you think. In fact, if you invest what would have been your down payment, the whole “throwing money out of the window” argument goes…well, out the window.
As far as the “I can’t lose on a house” thesis, well it’s just not true. Currently, house prices are down by 0.5% to 10%, depending on the measure used and are expected to fall further before we are done with the process. Of course if you hold a house over the long term, it should beat the inflation rate, but so too should the stock market. Like the stock market, real estate can in fact go through corrective periods, but thankfully, most people are not tempted and/or forced to sell at these low points. Since World War II, housing prices have lagged the performance of the stock market, but it just does not seem that way, because few people adjust the value of their homes for inflation—instead they say: I bought this house in 1965 for $40,000 and today it’s worth $400,000!”
I know that the notion of home ownership is engrained in our society—so much so that Uncle Sam helps you out with a mortgage interest deduction. But to quote economist Robert Shiller: “maybe we’ve gone too far in that only so many people can comfortably own homes, and it became an excuse for extravagant lending…Most people think home prices can’t fall for very long. The fact they haven’t since the Great Depression in a massive way is proof to many people … that they can’t fall. And I think the people are lacking the historical perspective that big events might come 70 years apart. And there’s remarkably little interest in historical episodes.”
Friday, December 14, 2007
The Steroid Era in Baseball and Subprime
Yesterday, Major League Baseball released “The Mitchell Report”, which culminated a 20-month investigation by former Senate Majority Leader George Mitchell, who was hired by Commissioner Bud Selig to examine the Steroids Era. The scathing 409-page treatise linked some of the game’s most famous players to illegal steroid and other performance-enhancing drug use, including Roger Clemens, Miguel Tejada, Barry Bonds, Gary Sheffield and Andy Pettitte. Scanning the report was a perfect activity for a snowy day!
Mr. Mitchell noted that "Everyone involved in baseball over the past two decades -- commissioners, club officials, the players' association and players -- shares to some extent the responsibility for the steroids era…There was a collective failure to recognize the problem as it emerged and to deal with it early on." As I read these words, I started to think about other excesses that occur under the nose of regulators.
Earlier this week, the Wall Street Journal reported that “In 2005, the Securities and Exchange Commission and New York state's attorney general's office launched separate investigations into whether Bear Stearns (the firm whose original disclosure sparked the subprime crisis) harmed investors by improperly valuing complex mortgage securities.” (Did Authorities Miss a Chance To Ease Crunch? December 10, 2007) In other words, like MLB officials who suspected steroid use in the past, there were problems that were percolating with the pricing of subprime fixed income securities that needed attention, but did not progress.
Both the SEC and the NY attorney general's office, headed at the time by Eliot Spitzer, identified the problem--that is, how to determine the value of securities backed by risky mortgages--but each regulatory body dropped the enforcement cases. Given the ensuing mess, I guess it would be naïve to expect that a regulator might admit “gee, we missed that one.” This is especially true of Eliot Spitzer, who many believe was better suited to building his case, publicizing “the most egregious allegations in the media, which put unbearable public pressure on the targets to settle.” (“The Humbling of Eliot Spitzer” The New Yorker, 12/10/07)
It is impossible to go back and hold Mr. Spitzer responsible for his inaction, just like it is difficult for MLB to figure out how to correct the past. In both cases, we fans would like to see more level-headed, proactive thinking, rather than the reactive sort that plagues the landscape in both industries.
Mr. Mitchell noted that "Everyone involved in baseball over the past two decades -- commissioners, club officials, the players' association and players -- shares to some extent the responsibility for the steroids era…There was a collective failure to recognize the problem as it emerged and to deal with it early on." As I read these words, I started to think about other excesses that occur under the nose of regulators.
Earlier this week, the Wall Street Journal reported that “In 2005, the Securities and Exchange Commission and New York state's attorney general's office launched separate investigations into whether Bear Stearns (the firm whose original disclosure sparked the subprime crisis) harmed investors by improperly valuing complex mortgage securities.” (Did Authorities Miss a Chance To Ease Crunch? December 10, 2007) In other words, like MLB officials who suspected steroid use in the past, there were problems that were percolating with the pricing of subprime fixed income securities that needed attention, but did not progress.
Both the SEC and the NY attorney general's office, headed at the time by Eliot Spitzer, identified the problem--that is, how to determine the value of securities backed by risky mortgages--but each regulatory body dropped the enforcement cases. Given the ensuing mess, I guess it would be naïve to expect that a regulator might admit “gee, we missed that one.” This is especially true of Eliot Spitzer, who many believe was better suited to building his case, publicizing “the most egregious allegations in the media, which put unbearable public pressure on the targets to settle.” (“The Humbling of Eliot Spitzer” The New Yorker, 12/10/07)
It is impossible to go back and hold Mr. Spitzer responsible for his inaction, just like it is difficult for MLB to figure out how to correct the past. In both cases, we fans would like to see more level-headed, proactive thinking, rather than the reactive sort that plagues the landscape in both industries.
Thursday, December 13, 2007
Vegas Baby
With all of the hoopla surrounding the Fed’s rate cut decision, I nearly forgot to write about my weekend in Las Vegas. I know it may sound crazy that a financial professional would celebrate her birthday in “sin city”, but I considered it research for human behavior and as an extension, investor decision-making.
I had not been to Las Vegas in over ten years and it sure has changed—at least superficially. The hotels are beautiful, the strip has been sanitized, but thankfully, things were pretty much the same in the casinos, where irrational exuberance was on parade. There is probably only one other industry where greed stomps on common sense and forces normally sane people to make terrible decisions—can you guess which one?
Before continuing, let me fully disclose one important fact: I am a terrible loser, which means that I am not a great candidate to enter a casino in the first place. But there I was, with half an hour to kill before dinner and a $10 minimum blackjack table a mere ten feet away. I joined two other guys and bought a whopping $60 worth of chips. We played a couple of hands and I was even, but then something magical occurred: the pit boss hovered over the dealer and asked him, “How have you allocated your 401(k)?” I burst out laughing, noting the irony.
Here is what the dealer said to the pit boss: “You need to diversify---I have some stock funds and also some bonds, which are safer. You know, I don’t need to be a pig with all of this. I just need to make a decent return, not beat the house.” At the same time this conversation was transpiring, the three people at the table, including yours truly, were losing six hands in a row. My $60 vanished in about twenty minutes, while the two other gents were in the hole for far more. One guy looked at me and said, “You know, I was up $600 before they started talking about their retirement accounts! Talk about a buzz kill---I’m out of here!”
Then I thought who better than the gaming industry professionals to understand the concept of long term investing? After all, they are forced to watch people learn the painful lessons of greed every day. The dealer must laugh as we dopes walk up to the table, thinking that we can actually beat the house. Only a sucker believes that the odds are in his favor---that’s why the folks, who actually work for the house, are talking about their retirement accounts, not the latest method of card counting. Vegas baby---you just gotta’ love it!
I had not been to Las Vegas in over ten years and it sure has changed—at least superficially. The hotels are beautiful, the strip has been sanitized, but thankfully, things were pretty much the same in the casinos, where irrational exuberance was on parade. There is probably only one other industry where greed stomps on common sense and forces normally sane people to make terrible decisions—can you guess which one?
Before continuing, let me fully disclose one important fact: I am a terrible loser, which means that I am not a great candidate to enter a casino in the first place. But there I was, with half an hour to kill before dinner and a $10 minimum blackjack table a mere ten feet away. I joined two other guys and bought a whopping $60 worth of chips. We played a couple of hands and I was even, but then something magical occurred: the pit boss hovered over the dealer and asked him, “How have you allocated your 401(k)?” I burst out laughing, noting the irony.
Here is what the dealer said to the pit boss: “You need to diversify---I have some stock funds and also some bonds, which are safer. You know, I don’t need to be a pig with all of this. I just need to make a decent return, not beat the house.” At the same time this conversation was transpiring, the three people at the table, including yours truly, were losing six hands in a row. My $60 vanished in about twenty minutes, while the two other gents were in the hole for far more. One guy looked at me and said, “You know, I was up $600 before they started talking about their retirement accounts! Talk about a buzz kill---I’m out of here!”
Then I thought who better than the gaming industry professionals to understand the concept of long term investing? After all, they are forced to watch people learn the painful lessons of greed every day. The dealer must laugh as we dopes walk up to the table, thinking that we can actually beat the house. Only a sucker believes that the odds are in his favor---that’s why the folks, who actually work for the house, are talking about their retirement accounts, not the latest method of card counting. Vegas baby---you just gotta’ love it!
Wednesday, December 12, 2007
Shred the Fed
The Fed cut the federal-funds rate by 1/4 point to 4.25% for the third consecutive meeting yesterday, citing increased "uncertainty" about growth and inflation. (The central bank also reduced the discount rate it charges banks for direct loans by a 1/4 point to 4.75%). The central bank dropped its previous assertion that growth and inflation risks were balanced and pledged to "act as needed" to keep the economy growing and inflation in check.
Within moments, the question shifted to: did the central bank do enough? Investors voted a resounding “no” and sold stocks broadly. The issue at hand is that without significant Fed intervention, many believe that tight financial conditions faced by corporate and individual borrowers will be exacerbated and as a result, the economy will tip into recession. That fear put a halt to the December rally, which prior to yesterday’s action, saw the Dow rise by 2.7%. The Dow Jones Industrial Average plunged 294.26, or 2.1%, to 13,432.77%; the S&P 500 sank 38.31, or 2.5%, to 1,477.65; and the Nasdaq Composite Index sagged 66.6, or 2.5%, to 2,652.35.
Within moments, the talking heads were bashing the bankers, but interestingly, the anti-Fed diatribes were flying even before the decision. Superstar investor/financier George Soros told the Wall Street Journal that “There’s no question that the Fed was remiss in the way they handled this [the sub-prime/credit crisis]. They are guided by a theory of the market which I think is false. The idea is that markets actually reflect reality and so you should really rely on the markets. And in fact, with all these new instruments it’s very difficult to calculate risk.”
I think that Soros probably is right in that the Fed needs to kick up its rate cuts, but before the decision, the expectation for a ½ point was running at only 38%, so what explains the big sell-off? Let’s back up and remember where we came from three weeks ago. On November 26th, stocks dropped to a level that qualified for a classic 10% correction from the top. Since that time, stocks started to rally as a couple of Fed officials, including the chairman himself, put December rate cuts back on the table. Once the decision was official, some investors worried that they had gotten a little ahead of themselves.
What now? Investors will likely continue to vacillate between excitement over future rate cuts (after yesterday’s decision, futures markets were pricing in a 94% probability of a ¼ point cut at the January meeting) and panic over a looming recession. The result will likely fall somewhere between the two, but getting there is sure going to be bumpy.
Within moments, the question shifted to: did the central bank do enough? Investors voted a resounding “no” and sold stocks broadly. The issue at hand is that without significant Fed intervention, many believe that tight financial conditions faced by corporate and individual borrowers will be exacerbated and as a result, the economy will tip into recession. That fear put a halt to the December rally, which prior to yesterday’s action, saw the Dow rise by 2.7%. The Dow Jones Industrial Average plunged 294.26, or 2.1%, to 13,432.77%; the S&P 500 sank 38.31, or 2.5%, to 1,477.65; and the Nasdaq Composite Index sagged 66.6, or 2.5%, to 2,652.35.
Within moments, the talking heads were bashing the bankers, but interestingly, the anti-Fed diatribes were flying even before the decision. Superstar investor/financier George Soros told the Wall Street Journal that “There’s no question that the Fed was remiss in the way they handled this [the sub-prime/credit crisis]. They are guided by a theory of the market which I think is false. The idea is that markets actually reflect reality and so you should really rely on the markets. And in fact, with all these new instruments it’s very difficult to calculate risk.”
I think that Soros probably is right in that the Fed needs to kick up its rate cuts, but before the decision, the expectation for a ½ point was running at only 38%, so what explains the big sell-off? Let’s back up and remember where we came from three weeks ago. On November 26th, stocks dropped to a level that qualified for a classic 10% correction from the top. Since that time, stocks started to rally as a couple of Fed officials, including the chairman himself, put December rate cuts back on the table. Once the decision was official, some investors worried that they had gotten a little ahead of themselves.
What now? Investors will likely continue to vacillate between excitement over future rate cuts (after yesterday’s decision, futures markets were pricing in a 94% probability of a ¼ point cut at the January meeting) and panic over a looming recession. The result will likely fall somewhere between the two, but getting there is sure going to be bumpy.
Tuesday, December 11, 2007
Holiday Cheer Part 2
Last week we began to identify ways to save or make money before the year-end. We started with taxable portfolio maneuvers that might help minimize capital gains distributions and that could help you take advantage of losing positions that are hanging around. Today it’s time to use Uncle Sam to help with retirement planning.
You have probably read all of the horrible statistics about how woefully underfunded retirement accounts are. While that is true, I am starting to see quite a bit of progress. Now when people call the radio show or come into our offices, I notice that they usually start by talking about their retirement accounts. That’s a good thing because the statistics about how long we will be retired are staggering. According to the National Center for Health Statistics, the average American who reaches 65 can expect to live nearly 19 more years, which is up about 35% since 1950! But the really wild thing to consider is that 19 years is an average, which means that many of us will live far longer.
Clearly longevity is the major issue facing folks who are planning for retirement, which means that contributing to your retirement account is becoming not just “something you ought to do” but an absolute necessity. Because many of the rules around retirement contributions are based on the calendar, you may only have these few weeks to get going—so let’s start with the basics.
You should try to contribute the maximum to your employer-sponsored plans. Some employers will allow you to alter your contribution in order to max-out by year-end. The limits for 2007 are as follows;
-401(k)/403(b)/457: $15,500 (if you are over age 50, you can make a $5,000 catch-up contribution)
-SIMPLE-IRA: $10,500 (if you are over age 50, you can make a $2,500 catch-up contribution)
Profit Sharing/Money Purchase/Keogh: $45,000
-IRA/Roth IRA: $4,000 (if you are over age 50, you can make a $1,000 catch-up contribution).
Remember, you do not need to make the IRA or Roth contribution until tax-filing time, but you might as well do it now, while you are thinking about it!
If you are self-employed and do not yet have a retirement plan, you need to establish one by December 31, 2007. Note: unlike IRA’s, these plans must be established by calendar year-end, not by tax filing deadline. Finally, if you are going to get a raise for 2008 and are not yet maxing out your plan, you should immediately change your contribution level.
With all of this found money, next week, we’re going to discuss how to give it away—a little more in keeping with the holiday spirit!
You have probably read all of the horrible statistics about how woefully underfunded retirement accounts are. While that is true, I am starting to see quite a bit of progress. Now when people call the radio show or come into our offices, I notice that they usually start by talking about their retirement accounts. That’s a good thing because the statistics about how long we will be retired are staggering. According to the National Center for Health Statistics, the average American who reaches 65 can expect to live nearly 19 more years, which is up about 35% since 1950! But the really wild thing to consider is that 19 years is an average, which means that many of us will live far longer.
Clearly longevity is the major issue facing folks who are planning for retirement, which means that contributing to your retirement account is becoming not just “something you ought to do” but an absolute necessity. Because many of the rules around retirement contributions are based on the calendar, you may only have these few weeks to get going—so let’s start with the basics.
You should try to contribute the maximum to your employer-sponsored plans. Some employers will allow you to alter your contribution in order to max-out by year-end. The limits for 2007 are as follows;
-401(k)/403(b)/457: $15,500 (if you are over age 50, you can make a $5,000 catch-up contribution)
-SIMPLE-IRA: $10,500 (if you are over age 50, you can make a $2,500 catch-up contribution)
Profit Sharing/Money Purchase/Keogh: $45,000
-IRA/Roth IRA: $4,000 (if you are over age 50, you can make a $1,000 catch-up contribution).
Remember, you do not need to make the IRA or Roth contribution until tax-filing time, but you might as well do it now, while you are thinking about it!
If you are self-employed and do not yet have a retirement plan, you need to establish one by December 31, 2007. Note: unlike IRA’s, these plans must be established by calendar year-end, not by tax filing deadline. Finally, if you are going to get a raise for 2008 and are not yet maxing out your plan, you should immediately change your contribution level.
With all of this found money, next week, we’re going to discuss how to give it away—a little more in keeping with the holiday spirit!
Wednesday, December 5, 2007
Nuanced Notions II
As we deconstruct the subprime fiasco and attempt to fix the problems, everyone has an opinion about where the fault lies for the whole mess. Some claim it was unscrupulous lenders, others say it was reckless borrowing. For the record, I think it was a little bit of both. Whenever we reach the peak points in any cycle, greed tends to distort everyone’s ability to make a rational decision and bad stuff happens.
Were there aggressive mortgage brokers who pushed people into loans that paid more handsome commissions? Sure there were—these are the same types who happily sold IPOs to the public in the late nineties when neither the sellers not the buyers were conversant in the risks that existed. But there were plenty of borrowers who today are crying foul, but back two years ago, were bragging to their neighbors about their low mortgage rates. It seems highly inconceivable that all of the borrowers were poor, unsuspecting souls. As in most booms and subsequent busts, there were probably some small number of out and out fraudulent loans and thankfully we have laws to deal with those. But the rest of those individuals and institutions who were caught up in the greed of the moment are probably paying the price they deserve to pay.
Regardless of where you fall on the blame issue, it is clear that the government is planning to get involved now. On Monday, Treasury Secretary Henry Paulson announced that he is aggressively pursuing an agreement with lenders and investor groups to freeze rates on subprime adjustable rate mortgages at their original levels. The plan is designed to prevent a surge in home foreclosures over the next year or so. I have a split opinion about the government involvement: as an investor, I like any action that helps to restore confidence in the economy and when Uncle Sam keeps your mortgage payments lower, you may have a few extra bucks to pump into the economy.
But then the CFP® in me takes over and becomes angry about the proposal. It’s people like me who kept providing counsel to clients, radio listeners and TV viewers, to “stick to the plain vanilla thirty-year fixed rate mortgage!” Now when there is supposed to be some sort of relief as a result of “doing the right thing”, the government pokes the responsible folks in the eye! The bail out seems unfair to those would-be homeowners, who waited patiently as they accumulated their 20% down payment to qualify for a conventional mortgage. To add insult to injury, the good guys now have to face the fact that as taxpayers, they will be forced to help bail out their irresponsible neighbors. Ouch—that smarts!
Were there aggressive mortgage brokers who pushed people into loans that paid more handsome commissions? Sure there were—these are the same types who happily sold IPOs to the public in the late nineties when neither the sellers not the buyers were conversant in the risks that existed. But there were plenty of borrowers who today are crying foul, but back two years ago, were bragging to their neighbors about their low mortgage rates. It seems highly inconceivable that all of the borrowers were poor, unsuspecting souls. As in most booms and subsequent busts, there were probably some small number of out and out fraudulent loans and thankfully we have laws to deal with those. But the rest of those individuals and institutions who were caught up in the greed of the moment are probably paying the price they deserve to pay.
Regardless of where you fall on the blame issue, it is clear that the government is planning to get involved now. On Monday, Treasury Secretary Henry Paulson announced that he is aggressively pursuing an agreement with lenders and investor groups to freeze rates on subprime adjustable rate mortgages at their original levels. The plan is designed to prevent a surge in home foreclosures over the next year or so. I have a split opinion about the government involvement: as an investor, I like any action that helps to restore confidence in the economy and when Uncle Sam keeps your mortgage payments lower, you may have a few extra bucks to pump into the economy.
But then the CFP® in me takes over and becomes angry about the proposal. It’s people like me who kept providing counsel to clients, radio listeners and TV viewers, to “stick to the plain vanilla thirty-year fixed rate mortgage!” Now when there is supposed to be some sort of relief as a result of “doing the right thing”, the government pokes the responsible folks in the eye! The bail out seems unfair to those would-be homeowners, who waited patiently as they accumulated their 20% down payment to qualify for a conventional mortgage. To add insult to injury, the good guys now have to face the fact that as taxpayers, they will be forced to help bail out their irresponsible neighbors. Ouch—that smarts!
Nuanced Notions Part 1
When the dot-com bubble burst, I was quick to judge my industry and my peers. I spoke up for the “little guy” and held in contempt those professionals that I thought took advantage of unsuspecting investors. How else to explain how 70-year old Mrs. Jones ended up with a $1 million IRA account? With a few years and a bit more wisdom, I have come to believe that it usually takes two to tango.
I have come to regret some of the harshness of my past criticism because it too quickly placed blame without a more nuanced understanding of how greed can grip buyers, sellers, promoters and even regulators. Please know that this is not to say that at any given time, there are some bad guys who do bad things. But generally speaking in my experience, those are outliers. That is why I approach the subprime issue with a bit more of a balanced approach. It’s time to come to terms with how the situation emerged, where the fault lies and the solution to get out of this mess.
No matter what kind of crisis emerges in the financial markets, it usually boils down to two simple concepts: greed and fear. When boom times occur and greed grips the landscape, people are careless. When I say people, I mean institutions, individuals and regulators. Everyone forgets all of the important lessons that we have learned in the past. That’s what happened in the late nineties---at some point, investor amnesia took hold and all of the sudden concepts like risk, over-concentration in individual sectors/industries and realistic performance expectations went out the window amid cheers of “it’s different this time!” Then something bad happens and fear infects the environment.
Now we have the same revisionist history when it comes to the subprime lending crisis. When interest rates dropped to rock-bottom levels, it encouraged financial service professionals to create new ways to put the cheap money to work and allowed “subprime” (those with low credit scores) and “Alt-A” borrowers (those who attained mortgages without having to support their income and asset levels with the normal documentation) to borrow money and purchase homes when maybe they should have been more conservative in their behavior.
When housing prices were rising and interest rates remained low, everything was fine. But as the market changed, so too did the ability of some of the borrowers to repay their loans, causing delinquencies and defaults. Now, many of the subprime and Alt-A borrowers are forgetting that they had something to do with this mess.
Earlier this week, no less than the venerable Wall Street Journal, seemed to imply that many borrowers were “duped” by unscrupulous lenders. Tomorrow, I will discuss whether these claims have merit and if they do, what are the ramifications for the housing and mortgage market.
I have come to regret some of the harshness of my past criticism because it too quickly placed blame without a more nuanced understanding of how greed can grip buyers, sellers, promoters and even regulators. Please know that this is not to say that at any given time, there are some bad guys who do bad things. But generally speaking in my experience, those are outliers. That is why I approach the subprime issue with a bit more of a balanced approach. It’s time to come to terms with how the situation emerged, where the fault lies and the solution to get out of this mess.
No matter what kind of crisis emerges in the financial markets, it usually boils down to two simple concepts: greed and fear. When boom times occur and greed grips the landscape, people are careless. When I say people, I mean institutions, individuals and regulators. Everyone forgets all of the important lessons that we have learned in the past. That’s what happened in the late nineties---at some point, investor amnesia took hold and all of the sudden concepts like risk, over-concentration in individual sectors/industries and realistic performance expectations went out the window amid cheers of “it’s different this time!” Then something bad happens and fear infects the environment.
Now we have the same revisionist history when it comes to the subprime lending crisis. When interest rates dropped to rock-bottom levels, it encouraged financial service professionals to create new ways to put the cheap money to work and allowed “subprime” (those with low credit scores) and “Alt-A” borrowers (those who attained mortgages without having to support their income and asset levels with the normal documentation) to borrow money and purchase homes when maybe they should have been more conservative in their behavior.
When housing prices were rising and interest rates remained low, everything was fine. But as the market changed, so too did the ability of some of the borrowers to repay their loans, causing delinquencies and defaults. Now, many of the subprime and Alt-A borrowers are forgetting that they had something to do with this mess.
Earlier this week, no less than the venerable Wall Street Journal, seemed to imply that many borrowers were “duped” by unscrupulous lenders. Tomorrow, I will discuss whether these claims have merit and if they do, what are the ramifications for the housing and mortgage market.
Tuesday, December 4, 2007
Holiday Cheer: Part 1
The year is winding down quickly and as I peruse the calendar, I realize that there is not much time to take advantage of some year-end financial action items. To help you maximize the time left in the year, over the next few weeks, I will provide tips for end-of-year planning, which hopefully will allow you to save or make more money before Santa arrives.
Today we’ll start with one of the best places to find money: in your taxable portfolio. While 2007 should have been a pretty good year for most investors, you may also find some assets that still have losses from the bad old years. Now is a great time to assess your portfolio and position it for the year ahead. Obviously taxes are not the only reason to buy or sell an investment, but if you can reap tax advantages while diversifying your portfolio or adjusting your asset allocation, you should definitely do so.
Consider selling the following assets:
Securities that have performed well this year, but whose prospects for continued growth are limited
Securities that have risen, causing your overall asset allocation to be different than your risk tolerance would suggest
Mutual Funds that have large capital gains distributions
While it makes sense to sell some losers, not all losers are created equal. Try not to alter your overall asset allocation strategy by selling too many investments. The best way to do this is to replace the loser with a similar asset, without facing the “wash-sale rule,” which is the IRS rule that ensures that you are not taking losses in one security as you invest in a “substantially identical” investment within 30 days of your sale. One way to avoid this is to replace a traditional open-ended mutual fund with a cheaper exchange-traded fund, thereby taking your loss and reducing the fee you pay for your investment.
Additionally, if you are thinking of dumping out of a loser mutual fund, do so quickly. Most mutual funds distribute annual capital gains during the month of December so if you are planning a year-end sale, get going! Remember that even those mutual funds that have gone down this year could still distribute long-term capital gains. Additionally, some funds are distributing large gains, while other similar funds may not. Consider swapping funds to reduce taxable distributions.
Beware of potential tax law changes: Until 1997, the long-term (investments held for over one year) capital gains rate was 28% and was then reduced to 20% until 2003. Since the tax cuts of 2003 were enacted, the top rate of long-term capital gains has been 15%, but it's set to rise to 20% in 2011. While it would be nice if capital gains rates stayed at these rock-bottom levels, it is probably more realistic to assume that rates will increase in the future. Many tax experts expect that if a Democrat assumes control of the White House, he or she will move quickly to raise the top rate even higher than 20%, perhaps back to 28%.
While I am never one to let the tax tail wag the investment dog, I have been advising clients to consider selling off concentrated low-basis positions in 2007 and 2008 to capture the current rate, as long as selling the asset will better diversify the portfolio. The potential window of opportunity could save significant dollars and perhaps might push you to do something that you have been meaning to do for some time (“I really should sell off some of Nana’s IBM, but I hate to pay the taxes!”) You should consult your advisor or accountant to discuss the implications of executing this strategy. Clearly investors should sell assets only after careful consideration of individual circumstances.
This is just a start—next week, we will discuss additional year-end strategies to boost your holiday cheer!
Today we’ll start with one of the best places to find money: in your taxable portfolio. While 2007 should have been a pretty good year for most investors, you may also find some assets that still have losses from the bad old years. Now is a great time to assess your portfolio and position it for the year ahead. Obviously taxes are not the only reason to buy or sell an investment, but if you can reap tax advantages while diversifying your portfolio or adjusting your asset allocation, you should definitely do so.
Consider selling the following assets:
Securities that have performed well this year, but whose prospects for continued growth are limited
Securities that have risen, causing your overall asset allocation to be different than your risk tolerance would suggest
Mutual Funds that have large capital gains distributions
While it makes sense to sell some losers, not all losers are created equal. Try not to alter your overall asset allocation strategy by selling too many investments. The best way to do this is to replace the loser with a similar asset, without facing the “wash-sale rule,” which is the IRS rule that ensures that you are not taking losses in one security as you invest in a “substantially identical” investment within 30 days of your sale. One way to avoid this is to replace a traditional open-ended mutual fund with a cheaper exchange-traded fund, thereby taking your loss and reducing the fee you pay for your investment.
Additionally, if you are thinking of dumping out of a loser mutual fund, do so quickly. Most mutual funds distribute annual capital gains during the month of December so if you are planning a year-end sale, get going! Remember that even those mutual funds that have gone down this year could still distribute long-term capital gains. Additionally, some funds are distributing large gains, while other similar funds may not. Consider swapping funds to reduce taxable distributions.
Beware of potential tax law changes: Until 1997, the long-term (investments held for over one year) capital gains rate was 28% and was then reduced to 20% until 2003. Since the tax cuts of 2003 were enacted, the top rate of long-term capital gains has been 15%, but it's set to rise to 20% in 2011. While it would be nice if capital gains rates stayed at these rock-bottom levels, it is probably more realistic to assume that rates will increase in the future. Many tax experts expect that if a Democrat assumes control of the White House, he or she will move quickly to raise the top rate even higher than 20%, perhaps back to 28%.
While I am never one to let the tax tail wag the investment dog, I have been advising clients to consider selling off concentrated low-basis positions in 2007 and 2008 to capture the current rate, as long as selling the asset will better diversify the portfolio. The potential window of opportunity could save significant dollars and perhaps might push you to do something that you have been meaning to do for some time (“I really should sell off some of Nana’s IBM, but I hate to pay the taxes!”) You should consult your advisor or accountant to discuss the implications of executing this strategy. Clearly investors should sell assets only after careful consideration of individual circumstances.
This is just a start—next week, we will discuss additional year-end strategies to boost your holiday cheer!
Monday, December 3, 2007
Maybe I can Protect you from Yourself…
Last week I wrote about “Jack”, a client who had directed us to liquidate all of the securities in his account. Despite our exhortations, Jack was unflappable and all of the positions were sold on MONDAY---yes, last Monday, which was the day before the big back-to-back stock market rally on Tuesday and Wednesday.
Jack came in on Friday morning to provide me with the rationale for his action. As I walked into the office, I looked at him and said, “I am so mad at you! How could you do that to my beautiful portfolio?” Jack grinned sheepishly and admitted that he knew that I would give him an earful about his bail-out. After an eight-year relationship with Jack and his wife, I wondered why he did not even ask to talk to me about the decision. The answer was obvious: had Jack spoken to me, I simply would have not let him do it and he very desperately wanted to sell.
“When I realized that I had lost $20,000 in one week, it just made me go off the deep end,” he admitted. When I probed further, Jack said that he had felt worried over the summer, but when the markets recovered, he thought that we had dodged a bullet. As the downside pressure mounted, he became more and more anxious. “Why didn’t you call me to talk about it?” I wondered. He just didn’t want to feel like a wimp, but then time wore on and the emotions grabbed hold.
I told Jack that even if he was right for a few days and the market continued to slide, his rationale was ill-founded. Then I went back to the drawing board and reminded Jack that he had a balanced portfolio; that he did not need to access the money in the account for at least a few years; that the account was up 7.5% this year; and most importantly, that he pays me to actively manage this money for him, so he had to let me do just that. He heard all of my explanations and said, “What should I do now?” Ah, the magic words that I needed to hear!
Last week I noted that Jack would be faced with a terrible decision: “either admit that he made a mistake and get back into the market or significantly reduce his spending while sitting in a money market account.” Thankfully, Jack chose the former and by the end of the day, his portfolio was repositioned. The snap decision cost Jack a few bucks, but in the end, at least he had the wisdom to see the error in his ways. Every so often, maybe I can help protect people from themselves!
Jack came in on Friday morning to provide me with the rationale for his action. As I walked into the office, I looked at him and said, “I am so mad at you! How could you do that to my beautiful portfolio?” Jack grinned sheepishly and admitted that he knew that I would give him an earful about his bail-out. After an eight-year relationship with Jack and his wife, I wondered why he did not even ask to talk to me about the decision. The answer was obvious: had Jack spoken to me, I simply would have not let him do it and he very desperately wanted to sell.
“When I realized that I had lost $20,000 in one week, it just made me go off the deep end,” he admitted. When I probed further, Jack said that he had felt worried over the summer, but when the markets recovered, he thought that we had dodged a bullet. As the downside pressure mounted, he became more and more anxious. “Why didn’t you call me to talk about it?” I wondered. He just didn’t want to feel like a wimp, but then time wore on and the emotions grabbed hold.
I told Jack that even if he was right for a few days and the market continued to slide, his rationale was ill-founded. Then I went back to the drawing board and reminded Jack that he had a balanced portfolio; that he did not need to access the money in the account for at least a few years; that the account was up 7.5% this year; and most importantly, that he pays me to actively manage this money for him, so he had to let me do just that. He heard all of my explanations and said, “What should I do now?” Ah, the magic words that I needed to hear!
Last week I noted that Jack would be faced with a terrible decision: “either admit that he made a mistake and get back into the market or significantly reduce his spending while sitting in a money market account.” Thankfully, Jack chose the former and by the end of the day, his portfolio was repositioned. The snap decision cost Jack a few bucks, but in the end, at least he had the wisdom to see the error in his ways. Every so often, maybe I can help protect people from themselves!
Friday, November 30, 2007
America for Sale?
I guess Lou Dobbs is going to have to change his rhetoric. Evidently we need not worry about illegal Mexican immigrants or Chinese world domination right now. After the deals announced earlier this week, it’s time to turn our xenophobic and protectionist attention to the Arabs!
Of course I am saying this partially tongue-in-cheek, but it is clear that some nations around the world reap the windfall of large trade surpluses, high oil prices and the foreign exchange that comes from currency transactions, many Asian countries and oil exporters hold more reserves than they need. Governments are putting pressure on their central banks to earn higher returns than those on the safe, liquid Treasury securities that most hold and as a result have established “sovereign-wealth funds” as a means to invest in a variety of assets across the globe.
The latest splash by a sovereign fund was the deal announced earlier this week between Citigroup and the Abu Dhabi Investment Authority (ADIA), the investment arm of the Abu Dhabi government. Citi, which has been suffering from subprime woes, received a $7.5 billion capital infusion from ADIA, in exchange for convertible stock in Citi yielding a rich 11% annually. The ADIA stake in the US’s largest bank will amount to 4.9%, exceeding the position held by Saudi Prince Alwaleed bin Talal, long known as one of Citi's largest shareholders and one of the key players in ousting Citi CEO Chuck Prince last month.
For paranoid types, it may be a little unnerving that 8% of Citi is now held by Arabs, but it is not the first institution to benefit from foreign investors. Beleaguered Bear Stearns cut a deal with Chinese investment bank Citis Securities to shore up liquidity; DIC, the investment arm of Dubai Holding (a conglomerate owned by Sheikh Mohammed bin Rashid al-Maktoum) plunked down more than $1 billion for a 9.9% stake in Och-Ziff Capital Management Group, a U.S. hedge-fund manager and this week bought a stake in Sony.
All of this activity is going to catch the attention of those who are already anxious about foreign investment in the US, but weren’t these the same people who were worried about Japan purchasing American assets in the eighties? It is clear that the world is shifting and the capital that is flowing is a natural extension of those changes. Assuming that there is no national security interest involved, I can’t see why investors would not want to see the trend continue.
To some extent, the genie is out of the bottle: according to the Financial Times, investment funds from the Middle East and Asia have invested an estimated $37 billion in shares of western financial companies this year and Morgan Stanley predicts that sovereign-wealth fund investments will grow to $27.7 trillion by 2022 from about $2.5 trillion today.
Of course I am saying this partially tongue-in-cheek, but it is clear that some nations around the world reap the windfall of large trade surpluses, high oil prices and the foreign exchange that comes from currency transactions, many Asian countries and oil exporters hold more reserves than they need. Governments are putting pressure on their central banks to earn higher returns than those on the safe, liquid Treasury securities that most hold and as a result have established “sovereign-wealth funds” as a means to invest in a variety of assets across the globe.
The latest splash by a sovereign fund was the deal announced earlier this week between Citigroup and the Abu Dhabi Investment Authority (ADIA), the investment arm of the Abu Dhabi government. Citi, which has been suffering from subprime woes, received a $7.5 billion capital infusion from ADIA, in exchange for convertible stock in Citi yielding a rich 11% annually. The ADIA stake in the US’s largest bank will amount to 4.9%, exceeding the position held by Saudi Prince Alwaleed bin Talal, long known as one of Citi's largest shareholders and one of the key players in ousting Citi CEO Chuck Prince last month.
For paranoid types, it may be a little unnerving that 8% of Citi is now held by Arabs, but it is not the first institution to benefit from foreign investors. Beleaguered Bear Stearns cut a deal with Chinese investment bank Citis Securities to shore up liquidity; DIC, the investment arm of Dubai Holding (a conglomerate owned by Sheikh Mohammed bin Rashid al-Maktoum) plunked down more than $1 billion for a 9.9% stake in Och-Ziff Capital Management Group, a U.S. hedge-fund manager and this week bought a stake in Sony.
All of this activity is going to catch the attention of those who are already anxious about foreign investment in the US, but weren’t these the same people who were worried about Japan purchasing American assets in the eighties? It is clear that the world is shifting and the capital that is flowing is a natural extension of those changes. Assuming that there is no national security interest involved, I can’t see why investors would not want to see the trend continue.
To some extent, the genie is out of the bottle: according to the Financial Times, investment funds from the Middle East and Asia have invested an estimated $37 billion in shares of western financial companies this year and Morgan Stanley predicts that sovereign-wealth fund investments will grow to $27.7 trillion by 2022 from about $2.5 trillion today.
Thursday, November 29, 2007
I Can’t Protect you from Yourself
Remember way back on Monday? You know, when stocks fell by almost 2%, fulfilling the definition of a “correction”. It was on that day that “Jack” called the office and calmly directed us to liquidate all of the securities in his account. After begging and pleading for him not to take any action, he said, “I just do not want to lose any money. I know that I will probably regret it, but I just have to do it.”
There are times in my job when I just can’t protect people from themselves. Maybe the stock market will fall back to Monday’s lows, but on Tuesday, stocks recovered almost all of Monday’s losses. Then yesterday, the bulls ran wild on hopes for a rate cut, a recovery in the battered financial sector and sinking oil prices.
The Dow Jones Industrial Average surged 331.01 points, or 2.6%, to 13289.45. All 30 of its components ended the day higher, as the index enjoyed its second-biggest point gain of the year. The Dow's gains yesterday capped a two-day rally of more than 540 points -- the best two-day performance since October 2002. The broader indexes joined in the fun: the S&P 500 advanced 40.79, or 2.9%, to 1469.02, and the Nasdaq Composite Index jumped 82.11, or 3.2%, to 2662.91.
What can I possibly say to Jack now? That I am sorry that he couldn’t be reasoned with? That if he just let us do our job and manage his money proactively, we would prevent him from letting his emotions get the best of him? Jack can not afford to sit in cash for the balance of his retirement-he needs to grow his money to outpace inflation. Not only that, but the biggest problem with making a rash decision like selling every asset you own is that even if you are right for a day, a week or a month, what will make you want to get back in?
I know that market volatility can be difficult to absorb, especially when you are retired and need your nest egg. But Jack knew that he had a balanced portfolio, which could withstand far more grief than what we have seen this year. Somehow that didn’t matter in the heat of the moment and now, Jack is faced with a terrible decision: either admit that he made a mistake and get back into the market or significantly reduce his spending while he sits in a money market account. Those choices seem pretty stinky to me, but sometimes no matter how hard I try, I just can’t save some investors from themselves.
There are times in my job when I just can’t protect people from themselves. Maybe the stock market will fall back to Monday’s lows, but on Tuesday, stocks recovered almost all of Monday’s losses. Then yesterday, the bulls ran wild on hopes for a rate cut, a recovery in the battered financial sector and sinking oil prices.
The Dow Jones Industrial Average surged 331.01 points, or 2.6%, to 13289.45. All 30 of its components ended the day higher, as the index enjoyed its second-biggest point gain of the year. The Dow's gains yesterday capped a two-day rally of more than 540 points -- the best two-day performance since October 2002. The broader indexes joined in the fun: the S&P 500 advanced 40.79, or 2.9%, to 1469.02, and the Nasdaq Composite Index jumped 82.11, or 3.2%, to 2662.91.
What can I possibly say to Jack now? That I am sorry that he couldn’t be reasoned with? That if he just let us do our job and manage his money proactively, we would prevent him from letting his emotions get the best of him? Jack can not afford to sit in cash for the balance of his retirement-he needs to grow his money to outpace inflation. Not only that, but the biggest problem with making a rash decision like selling every asset you own is that even if you are right for a day, a week or a month, what will make you want to get back in?
I know that market volatility can be difficult to absorb, especially when you are retired and need your nest egg. But Jack knew that he had a balanced portfolio, which could withstand far more grief than what we have seen this year. Somehow that didn’t matter in the heat of the moment and now, Jack is faced with a terrible decision: either admit that he made a mistake and get back into the market or significantly reduce his spending while he sits in a money market account. Those choices seem pretty stinky to me, but sometimes no matter how hard I try, I just can’t save some investors from themselves.
Wednesday, November 28, 2007
Investors Stand Corrected
As readers of this column know, I like it when the market falls. Don’t get me wrong, I don’t relish other people losing money, but when any asset class moves up dramatically without taking a breather, it makes me wary. Well, my anxieties have been addressed this week, as stocks opened the week with quite a tumble.
On Monday, the Dow Jones Industrial Average fell 237.44 points to 12743.44, a full 10% below its October 9th record close of 14164.53. The S&P 500 index fell 2.3% on Monday and by the end of the day, was down 10.1% from its October 9th record. The magical 10% pull-back is known as a “correction,” which is half-way to a full-fledged bear market, usually defined as a 20% drop.
Investors have been spoiled over the past five years, in that there has only been one correction—at the beginning of 2003, when the US was preparing to invade Iraq. Since then, there has certainly been upside and downside volatility, but we have not seen a decline of 10% and that is an aberration. Until the bull market of the nineties, corrections were more commonplace and investors actually expected them to come along.
According to quick research that I conducted on line, there have been over 40 corrections since World War II. (Ned Davis Research says that there have been 43, while Bespoke Investment Group counted 45—suffice to say that there have been a bunch of them!) What seems clear is that the duration of the pullbacks has shrunk over time. Since 1990, corrections have lasted an average of 88 days from an average of 146 days between 1945 and 2007. The number of days that expire between reaching a 10 percent decline and the low point of the slide also has shrunk, to 43 days from 68 days.
With the 10% move, many are preparing for the worst: a continued slide that would make 2007 the first losing year for investors since 2002. But is that likely? To understand, let’s take a look at the last five times the Dow fell 10% from its previous high (January, 2003; June, 2002; February, 2000; October, 1999; and August, 1998). In all but one case (June, 2002), the Dow was higher at both six and twelve months later. Of course, past performance is no indication of future success, but sometimes it is helpful to consult the history books to assuage frayed nerves.
What is abundantly clear is that markets are likely to be volatile in the future, so if you have lost sleep over your portfolio’s performance, it’s probably a good sign that you need to adjust your allocation to a less aggressive stance. Seasoned investors understand that it is imperative to understand how much risk they can tolerate and model their portfolios accordingly. In my experience, some of the worst investment decisions are made after investors overestimate their risk tolerance, then find themselves in a state of high anxiety and sell when markets move against them, often throwing away months or years of gains during one episode of panic selling. Indeed, that is a far more painful correction than the market’s 10% pullback. Just imagine how sellers on Monday felt on Tuesday after the big snap-back rally.
On Monday, the Dow Jones Industrial Average fell 237.44 points to 12743.44, a full 10% below its October 9th record close of 14164.53. The S&P 500 index fell 2.3% on Monday and by the end of the day, was down 10.1% from its October 9th record. The magical 10% pull-back is known as a “correction,” which is half-way to a full-fledged bear market, usually defined as a 20% drop.
Investors have been spoiled over the past five years, in that there has only been one correction—at the beginning of 2003, when the US was preparing to invade Iraq. Since then, there has certainly been upside and downside volatility, but we have not seen a decline of 10% and that is an aberration. Until the bull market of the nineties, corrections were more commonplace and investors actually expected them to come along.
According to quick research that I conducted on line, there have been over 40 corrections since World War II. (Ned Davis Research says that there have been 43, while Bespoke Investment Group counted 45—suffice to say that there have been a bunch of them!) What seems clear is that the duration of the pullbacks has shrunk over time. Since 1990, corrections have lasted an average of 88 days from an average of 146 days between 1945 and 2007. The number of days that expire between reaching a 10 percent decline and the low point of the slide also has shrunk, to 43 days from 68 days.
With the 10% move, many are preparing for the worst: a continued slide that would make 2007 the first losing year for investors since 2002. But is that likely? To understand, let’s take a look at the last five times the Dow fell 10% from its previous high (January, 2003; June, 2002; February, 2000; October, 1999; and August, 1998). In all but one case (June, 2002), the Dow was higher at both six and twelve months later. Of course, past performance is no indication of future success, but sometimes it is helpful to consult the history books to assuage frayed nerves.
What is abundantly clear is that markets are likely to be volatile in the future, so if you have lost sleep over your portfolio’s performance, it’s probably a good sign that you need to adjust your allocation to a less aggressive stance. Seasoned investors understand that it is imperative to understand how much risk they can tolerate and model their portfolios accordingly. In my experience, some of the worst investment decisions are made after investors overestimate their risk tolerance, then find themselves in a state of high anxiety and sell when markets move against them, often throwing away months or years of gains during one episode of panic selling. Indeed, that is a far more painful correction than the market’s 10% pullback. Just imagine how sellers on Monday felt on Tuesday after the big snap-back rally.
Tuesday, November 27, 2007
Shop ’til you Drop
The early results are in and I am pleased to report that the patient is not just alive, but pretty darned feisty! The American consumer came through over the first big weekend of the holiday sales season, although experts are still on pins and needles to see how we will perform for the next 28 days until Christmas Day.
Perhaps you are wondering why there is so much fascination with this one weekend and why special terms, like “Black Friday” (named for the day on which retailers traditionally become profitable on the year, or “go into the black”) and “Cyber Monday” (the Monday after Thanksgiving when on-line shopping cranks up dramatically), have entered the American lexicon. Retailers’ performance over the Thanksgiving weekend is closely watched because it accounts for up to 8%, or roughly $40 billion, of all holiday sales, which are expected to reach $475 billion this year, according to the National Retail Federation.
While every holiday season is important, 2007 seems more crucial than usual. The reason is that uncertainty is shaking the confidence of investors and consumers alike, as the flow of concerns like the continuing housing recession; the credit fall out from the sub-prime mortgage fiasco; and spiking energy prices are fraying even the steadiest of nerves. As a result of all of those issues, it is expected that retail sales growth this season will be the weakest since 2002, the third year of a disastrous bear market.
When the early results came in, there were was some good news and some bad news. First the good news: according to the research firm ShopperTrak, retail sales rose 8.3% on Friday compared with last year, the biggest increase in three years. On Friday and Saturday combined, sales rose 7.2%, which was a nifty feat in the face of the negative news coursing through the mainstream media. However, it looks like this season consumers are not exactly splurging.
Shoppers sought bargains and spent an estimated $348 each over the 2007 Thanksgiving holiday weekend, down from $360 last year, a survey conducted for the National Retail Federation found. But here is something that you might not read about—the year before—2005, when the housing market was still booming, the average was $303. I don’t want to be too rosy, too early, but I am impressed that the news was as good as it was. With 28 days to go (and one Federal Reserve meeting sandwiched in between), it will be interesting to see whether consumers can maintain their early pace or succumb to the wall of worry they see ahead.
Perhaps you are wondering why there is so much fascination with this one weekend and why special terms, like “Black Friday” (named for the day on which retailers traditionally become profitable on the year, or “go into the black”) and “Cyber Monday” (the Monday after Thanksgiving when on-line shopping cranks up dramatically), have entered the American lexicon. Retailers’ performance over the Thanksgiving weekend is closely watched because it accounts for up to 8%, or roughly $40 billion, of all holiday sales, which are expected to reach $475 billion this year, according to the National Retail Federation.
While every holiday season is important, 2007 seems more crucial than usual. The reason is that uncertainty is shaking the confidence of investors and consumers alike, as the flow of concerns like the continuing housing recession; the credit fall out from the sub-prime mortgage fiasco; and spiking energy prices are fraying even the steadiest of nerves. As a result of all of those issues, it is expected that retail sales growth this season will be the weakest since 2002, the third year of a disastrous bear market.
When the early results came in, there were was some good news and some bad news. First the good news: according to the research firm ShopperTrak, retail sales rose 8.3% on Friday compared with last year, the biggest increase in three years. On Friday and Saturday combined, sales rose 7.2%, which was a nifty feat in the face of the negative news coursing through the mainstream media. However, it looks like this season consumers are not exactly splurging.
Shoppers sought bargains and spent an estimated $348 each over the 2007 Thanksgiving holiday weekend, down from $360 last year, a survey conducted for the National Retail Federation found. But here is something that you might not read about—the year before—2005, when the housing market was still booming, the average was $303. I don’t want to be too rosy, too early, but I am impressed that the news was as good as it was. With 28 days to go (and one Federal Reserve meeting sandwiched in between), it will be interesting to see whether consumers can maintain their early pace or succumb to the wall of worry they see ahead.
Monday, November 26, 2007
Giving Thanks
The stock market is down, oil is nearing $100, the US dollar is plunging and the world’s retailers are on edge as they calculate their take from “Black Friday” and “Cyber Monday”. I guess that we can all understand how the general anxiety about the economy can creep in and prevent us from doing what we should be at this time of year: giving thanks. Before you lose that thought, put down your leftover turkey sandwich so I can recount a story.
I was supposed to take off Friday, but after checking my voice mail, it was clear that I needed to make a quick call to a client who left a disturbing message. “Mike” was fearful that he would be let go from his high paying job at a large company in Boston and called me to develop a game plan if the worst were to occur. By the time I called back, he had found out that his job was secure and that the firm had even given him a retention bonus to stay through the end of the year.
“I can’t believe that they only think that I am worth an extra $250,000!” he said with equal parts of sarcasm and anger. I know that Mike knows that he is paid well compared to the vast majority of people in this country, but he fell prey to comparing himself to the tiny minority that earns far more than he does. Who among us has not thought, “I can’t believe that guy/gal makes so much money!” Maybe it was the realtor who caught a hot market, the doctor who went into radiology rather than primary care medicine or the lawyer who chose corporate work instead of becoming a public defender. In all walks of life, there are instances where we all know that the earning power of a particular professional has no bearing to merit or even achievement.
Sometimes people choose careers in areas of the economy that are rewarded far more lucratively than others. If you are a numbers person and you become a math professor, you are not going to make as much as the guy who sat next to you who is now an analyst for an investment bank. In my own life I have experienced this very feeling. I left the commodities exchange in the early nineties. Had I stayed, I would be making a fortune right now. But that was not how I wanted to spend my career. Is it fair that the dopes who worked along side me are now cashing in? I don’t really know, but who cares---I don’t want to be there.
To start the week after Thanksgiving and of course, the holiday bonus season, it would probably go a long way if we all remember the gifts in our lives. On balance, most of us are fortunate to have what we have. We live in the best country in the world, where we are free to dissent with those in power. Most of us have decent jobs that allow us to provide shelter, food and a pretty nice lifestyle. We may not be making a ga-zillion bucks in stock options or cashing out millions for being in the right job at the right time, but we are blessed. My advice for you as we enter the heart of the holiday season is to remember all that is good in your life, not what is lacking.
I was supposed to take off Friday, but after checking my voice mail, it was clear that I needed to make a quick call to a client who left a disturbing message. “Mike” was fearful that he would be let go from his high paying job at a large company in Boston and called me to develop a game plan if the worst were to occur. By the time I called back, he had found out that his job was secure and that the firm had even given him a retention bonus to stay through the end of the year.
“I can’t believe that they only think that I am worth an extra $250,000!” he said with equal parts of sarcasm and anger. I know that Mike knows that he is paid well compared to the vast majority of people in this country, but he fell prey to comparing himself to the tiny minority that earns far more than he does. Who among us has not thought, “I can’t believe that guy/gal makes so much money!” Maybe it was the realtor who caught a hot market, the doctor who went into radiology rather than primary care medicine or the lawyer who chose corporate work instead of becoming a public defender. In all walks of life, there are instances where we all know that the earning power of a particular professional has no bearing to merit or even achievement.
Sometimes people choose careers in areas of the economy that are rewarded far more lucratively than others. If you are a numbers person and you become a math professor, you are not going to make as much as the guy who sat next to you who is now an analyst for an investment bank. In my own life I have experienced this very feeling. I left the commodities exchange in the early nineties. Had I stayed, I would be making a fortune right now. But that was not how I wanted to spend my career. Is it fair that the dopes who worked along side me are now cashing in? I don’t really know, but who cares---I don’t want to be there.
To start the week after Thanksgiving and of course, the holiday bonus season, it would probably go a long way if we all remember the gifts in our lives. On balance, most of us are fortunate to have what we have. We live in the best country in the world, where we are free to dissent with those in power. Most of us have decent jobs that allow us to provide shelter, food and a pretty nice lifestyle. We may not be making a ga-zillion bucks in stock options or cashing out millions for being in the right job at the right time, but we are blessed. My advice for you as we enter the heart of the holiday season is to remember all that is good in your life, not what is lacking.
Wednesday, November 21, 2007
Oh Susannah!
Tomorrow my family will not only celebrate Thanksgiving, but my mother’s birthday too (talk about giving thanks!). A few years ago, a British tour guide called Mom “Susannah” (her real name is Susan), a nickname that has stuck. On her birthday, I like to re-run an article that I wrote a few years ago to honor her. I have edited parts, but the essence remains the same—today, it’s all about Susannah!
People often assume that because my father was a Wall Street trader and his father was the CEO of a publicly-traded company that my financial influences came through the Schlesinger side of the family. While that is true, it is also interesting to note that my mother’s clear, straight-forward world view about money significantly shaped my approach to finances and continues to imbue me with common sense wisdom. On the eve of her special day, it’s time to share with you some of her gems. You may recognize some of them from your own mothers!
Rich or poor, it’s nice to have money: My mother grew up in a middle class family that started to earn more money as she reached high school. In her formative years, her mother, a child significantly affected by the Depression, instilled in my mother the notion that while having money did not make you better than anyone else, it could provide security.
Money does not make you happy, but it can make your unhappiness more comfortable: This add-on to the previous mantra dovetails on Mom’s belief that money and planning can make many other problems, like health issues, easier to stand. This became clear as I watched my parents take care of their parents, three of whom lived into their nineties.
Money buys convenience and access—these things are inconsequential: Full disclosure here—my mother likes nice things, but she has always maintained that having a solid financial foundation provides opportunity and choice, both of which are far more important than jewelry, cars or fancy dinners.
Sound finances allow you not to worry about money: My mother watched many of her friends struggle with money issues throughout their lives and conversely, she also knew many people who had money and wasted their time trying to figure out how to get more. She has always believed that as long as she had what she needed, she could focus on other, more important parts of her life.
Never buy more house than you need: Mom is a realtor, famous for her line, “A house is like a man, there is more than one for you in the world.” A romantic she’s not, nor is she a fan of the idea that you should buy as big house as you can afford. I once heard her tell a client, “Don’t forget--you have to heat, air condition and take care of that big house too!”
I’d rather wear it than drive it: In the world of depreciating assets, Mom leans towards the kind that you can wear, not the kind you drive. She likes comfortable cars, but beyond that, she is not a fan of sinking lots of money into transportation. Clothes, now that’s another story…
Forget retirement---find something you love to do and do it as long as you possibly can: My mother’s father worked until he was 88 and that work ethic trickled down to her. The notion of retirement is foreign to Mom, so I suspect she will continue to work in some way, for many years to come. To her, retirement planning is really about finding the job that you want to keep doing for as long as possible.
People often assume that because my father was a Wall Street trader and his father was the CEO of a publicly-traded company that my financial influences came through the Schlesinger side of the family. While that is true, it is also interesting to note that my mother’s clear, straight-forward world view about money significantly shaped my approach to finances and continues to imbue me with common sense wisdom. On the eve of her special day, it’s time to share with you some of her gems. You may recognize some of them from your own mothers!
Rich or poor, it’s nice to have money: My mother grew up in a middle class family that started to earn more money as she reached high school. In her formative years, her mother, a child significantly affected by the Depression, instilled in my mother the notion that while having money did not make you better than anyone else, it could provide security.
Money does not make you happy, but it can make your unhappiness more comfortable: This add-on to the previous mantra dovetails on Mom’s belief that money and planning can make many other problems, like health issues, easier to stand. This became clear as I watched my parents take care of their parents, three of whom lived into their nineties.
Money buys convenience and access—these things are inconsequential: Full disclosure here—my mother likes nice things, but she has always maintained that having a solid financial foundation provides opportunity and choice, both of which are far more important than jewelry, cars or fancy dinners.
Sound finances allow you not to worry about money: My mother watched many of her friends struggle with money issues throughout their lives and conversely, she also knew many people who had money and wasted their time trying to figure out how to get more. She has always believed that as long as she had what she needed, she could focus on other, more important parts of her life.
Never buy more house than you need: Mom is a realtor, famous for her line, “A house is like a man, there is more than one for you in the world.” A romantic she’s not, nor is she a fan of the idea that you should buy as big house as you can afford. I once heard her tell a client, “Don’t forget--you have to heat, air condition and take care of that big house too!”
I’d rather wear it than drive it: In the world of depreciating assets, Mom leans towards the kind that you can wear, not the kind you drive. She likes comfortable cars, but beyond that, she is not a fan of sinking lots of money into transportation. Clothes, now that’s another story…
Forget retirement---find something you love to do and do it as long as you possibly can: My mother’s father worked until he was 88 and that work ethic trickled down to her. The notion of retirement is foreign to Mom, so I suspect she will continue to work in some way, for many years to come. To her, retirement planning is really about finding the job that you want to keep doing for as long as possible.
Tuesday, November 20, 2007
Pre-Thanksgiving Reminder II
Two days and counting until your brain shuts down for weeks on end. Before the post-Thanksgiving affliction known as “Holiday Brain Freeze” sets in, I’m providing reminders about the economy, financial markets and your own personal investing. Yesterday I started with the big stuff, but today’s focus is you.
As the markets continue to gyrate, I am starting to hear from people who are hyper-focused on their investment accounts. There have been questions about whether people should “do” anything, like sell stocks, or move out of dollar-denominated assets. Despite being through difficult periods like this in the past, investors have short memories. Before we get into over-stuffed Thanksgiving week highs, today we are going back to one of my favorite topics: investors often are their own worst enemies.
According to reams of research, the average stock mutual fund investor has not performed as well as the S&P 500 index. Research firm Dalbar conducted a survey called “Quantitative Analysis of Investor Behavior” which compared the annualized return for the index versus the average stock fund investor from 1986-2005. During this time frame, the index returned 11.9%, while investors returned 3.9%. An 8% differential is amazing and I attribute it to the oldest lesson in the investment book: investors can be led astray by their emotions.
When they see that assets are dropping, they are tempted to sell, while when they are rising, they pile in. In other words, they sell low and buy high. I saw this first-hand over the past few weeks with the questions mentioned above. When stocks were making new highs in July, I did not field one question from a client or a radio listener who wondered whether they should trim gains or perhaps reduce risk. But now that volatility has gripped markets, the anxiety level is creeping into the minds of investors.
How can you manage these trying times? There are three distinctive steps that help seasoned investors withstand the ups and downs of the market. You know these deep down, but it’s worth a reminder, especially as the unofficial kick-off of the holiday season is upon us.
1) Create an investment plan that outlines what you are trying to accomplish. This plan should incorporate your risk tolerance and take into account your time horizon.
2) Prevent your emotions from taking over by crating an asset allocation plan that you periodically check
3) Integrate your investment plan into your larger wealth management plan.
And if you can’t seem to manage the process yourself, by all means, hire a professional who can. Sometimes professional management and peace of mind are well worth the price of service.
As the markets continue to gyrate, I am starting to hear from people who are hyper-focused on their investment accounts. There have been questions about whether people should “do” anything, like sell stocks, or move out of dollar-denominated assets. Despite being through difficult periods like this in the past, investors have short memories. Before we get into over-stuffed Thanksgiving week highs, today we are going back to one of my favorite topics: investors often are their own worst enemies.
According to reams of research, the average stock mutual fund investor has not performed as well as the S&P 500 index. Research firm Dalbar conducted a survey called “Quantitative Analysis of Investor Behavior” which compared the annualized return for the index versus the average stock fund investor from 1986-2005. During this time frame, the index returned 11.9%, while investors returned 3.9%. An 8% differential is amazing and I attribute it to the oldest lesson in the investment book: investors can be led astray by their emotions.
When they see that assets are dropping, they are tempted to sell, while when they are rising, they pile in. In other words, they sell low and buy high. I saw this first-hand over the past few weeks with the questions mentioned above. When stocks were making new highs in July, I did not field one question from a client or a radio listener who wondered whether they should trim gains or perhaps reduce risk. But now that volatility has gripped markets, the anxiety level is creeping into the minds of investors.
How can you manage these trying times? There are three distinctive steps that help seasoned investors withstand the ups and downs of the market. You know these deep down, but it’s worth a reminder, especially as the unofficial kick-off of the holiday season is upon us.
1) Create an investment plan that outlines what you are trying to accomplish. This plan should incorporate your risk tolerance and take into account your time horizon.
2) Prevent your emotions from taking over by crating an asset allocation plan that you periodically check
3) Integrate your investment plan into your larger wealth management plan.
And if you can’t seem to manage the process yourself, by all means, hire a professional who can. Sometimes professional management and peace of mind are well worth the price of service.
Monday, November 19, 2007
Pre-Thanksgiving Reminder I
Later this week we will celebrate the unofficial start of the holiday season. This fact may come as a surprise to you, considering that it barely has felt like autumn here in the Northeast, but indeed, the post-Thanksgiving affliction known as “Holiday Brain Freeze” is imminent. Before your attention is diverted to compiling your holiday shopping list, I am going to provide some reminders about the economy, financial markets and your own personal investing.
Let’s begin with some big picture stuff. You have probably been reading about the problems in the US economy, including housing woes, a falling US dollar and of course, a stock market that is well-off the highs of the year. In fact, I have rarely fielded so many questions about the potential for a recession after the economy has grown nearly 4% in the previous quarter. Still, it is widely expected that the current quarter will show a significant slow down and it is understandable that people are concerned. To quote my father: “things are rarely as good or as bad as you think.”
Because I am a trader, I always consider the biggest risk first: a recession. The definition of a recession is two consecutive quarters of negative growth. As noted above, the US economy grew by 3.9% in the third quarter of this year, so in order to be in a recession, things have to slow down – a lot. This is not to say that it can’t happen, but we do have a ways to go. And what if we do enter a recession? I am here to report that the US economy will be more than able to survive a recession and so too will you. Recessions are a natural part of the economic cycle and we should all stop worrying about whether or not one will occur: we will see more recessions and that’s OK.
What about the dollar decline? I have started to consider that now that the hysteria over the dollar has reached the mainstream media, our beloved greenback is more likely than not to stabilize from here. That being said, the fall of the dollar has many positive and restorative effects on the US economy by helping US exports and concurrently encouraging consumers to spend less on imports and save more. Remember those twin deficits? Well the falling dollar is correcting them, which is a good thing.
Finally, as my friend N. likes to say, there sure are lots of people “getting wrapped around the axel” about the stock market right now. Sure the stock market is off the highs, but it is not DOWN this year. And what if it does fall? Well, that means that new money going into your retirement account is purchasing shares at a lower level. If you are still in the accumulation phase of your life, market pull-backs actually benefit you in the long run. If you are about to retire or are already retired, then you should not be invested aggressively enough that a sell-off will blow up your long-term plan.
Tomorrow I will tackle a few more reminders before you drop-off into Turkey-induced la-la land.
Let’s begin with some big picture stuff. You have probably been reading about the problems in the US economy, including housing woes, a falling US dollar and of course, a stock market that is well-off the highs of the year. In fact, I have rarely fielded so many questions about the potential for a recession after the economy has grown nearly 4% in the previous quarter. Still, it is widely expected that the current quarter will show a significant slow down and it is understandable that people are concerned. To quote my father: “things are rarely as good or as bad as you think.”
Because I am a trader, I always consider the biggest risk first: a recession. The definition of a recession is two consecutive quarters of negative growth. As noted above, the US economy grew by 3.9% in the third quarter of this year, so in order to be in a recession, things have to slow down – a lot. This is not to say that it can’t happen, but we do have a ways to go. And what if we do enter a recession? I am here to report that the US economy will be more than able to survive a recession and so too will you. Recessions are a natural part of the economic cycle and we should all stop worrying about whether or not one will occur: we will see more recessions and that’s OK.
What about the dollar decline? I have started to consider that now that the hysteria over the dollar has reached the mainstream media, our beloved greenback is more likely than not to stabilize from here. That being said, the fall of the dollar has many positive and restorative effects on the US economy by helping US exports and concurrently encouraging consumers to spend less on imports and save more. Remember those twin deficits? Well the falling dollar is correcting them, which is a good thing.
Finally, as my friend N. likes to say, there sure are lots of people “getting wrapped around the axel” about the stock market right now. Sure the stock market is off the highs, but it is not DOWN this year. And what if it does fall? Well, that means that new money going into your retirement account is purchasing shares at a lower level. If you are still in the accumulation phase of your life, market pull-backs actually benefit you in the long run. If you are about to retire or are already retired, then you should not be invested aggressively enough that a sell-off will blow up your long-term plan.
Tomorrow I will tackle a few more reminders before you drop-off into Turkey-induced la-la land.
Thursday, November 15, 2007
Three Paths
Most investors wish that they could be on a merry-go-round, not a roller coaster. Of course we know that it is not possible, but consider three different portfolios that are invested over an eight-year period.
Path #1 Path #2 Path #3
YR 1 10% 38% (22%)
YR 2 10% 23% (12%)
YR 3 10% 33% (9%)
YR 4 10% 29% 21%
YR 5 10% 21% 29%
YR 6 10% (9%) 33%
YR 7 10% (12%) 23%
YR 8 10% (22%) 38%
It’s hard to believe, but the compound annual return of each portfolio is exactly the same --- 10% for all three portfolios! Obviously Path #1 would be nice, but again, just not going to happen. Yet people consistently set themselves up for disappointment by expecting the historic “10% return” to occur year after year, only to discover that most years it’s not 10% on the nose.
Considering that we all have to endure variability of returns, which is better, Path #2 or #3? You may think that Path #2 isn’t so bad, but if you have retired at the end of year 6, it’s pretty darned painful, and it is similarly difficult to begin retirement with three nasty, down years. The one nice thing is that if you are still saving for retirement, the three down years allow you to invest in your retirement account at lower levels.
But what would happen if you were already retired in all three paths? In that case, most people would be withdrawing money from their accounts. So if the portfolio in each path is worth $1,000,000 and you are planning to withdraw an inflation-adjusted $50,000 each year, you may be surprised to see what would happen over the course of the eight years. In Path #1, after eight years, the $1million portfolio would be worth $1.6 million, in Path #2, it would be worth $1.8 million and in Path #3 it would total $1.2 million. A $600,000 differential is pretty major!
The reason that I bring this up is that when you are about to retire, rarely do results move in a straight line. Your job is to ensure that regardless of market performance, you are taking into account the various outcomes that would impact your life.
Path #1 Path #2 Path #3
YR 1 10% 38% (22%)
YR 2 10% 23% (12%)
YR 3 10% 33% (9%)
YR 4 10% 29% 21%
YR 5 10% 21% 29%
YR 6 10% (9%) 33%
YR 7 10% (12%) 23%
YR 8 10% (22%) 38%
It’s hard to believe, but the compound annual return of each portfolio is exactly the same --- 10% for all three portfolios! Obviously Path #1 would be nice, but again, just not going to happen. Yet people consistently set themselves up for disappointment by expecting the historic “10% return” to occur year after year, only to discover that most years it’s not 10% on the nose.
Considering that we all have to endure variability of returns, which is better, Path #2 or #3? You may think that Path #2 isn’t so bad, but if you have retired at the end of year 6, it’s pretty darned painful, and it is similarly difficult to begin retirement with three nasty, down years. The one nice thing is that if you are still saving for retirement, the three down years allow you to invest in your retirement account at lower levels.
But what would happen if you were already retired in all three paths? In that case, most people would be withdrawing money from their accounts. So if the portfolio in each path is worth $1,000,000 and you are planning to withdraw an inflation-adjusted $50,000 each year, you may be surprised to see what would happen over the course of the eight years. In Path #1, after eight years, the $1million portfolio would be worth $1.6 million, in Path #2, it would be worth $1.8 million and in Path #3 it would total $1.2 million. A $600,000 differential is pretty major!
The reason that I bring this up is that when you are about to retire, rarely do results move in a straight line. Your job is to ensure that regardless of market performance, you are taking into account the various outcomes that would impact your life.
Wednesday, November 14, 2007
The Job of Advisor
I am attending an industry meeting this week and while sometimes these things can be a bore, this group is special: everyone in the room is a Registered Investment Advisor (RIA), which means that each of us has a fiduciary responsibility to our clients and has to register with the Securities and Exchange Commission. The group gathers twice a year to talk about what we believe our clients need from us and exchange information that helps us discover new ways to serve those clients.
Individuals choose to work with registered investment advisors for lots of different reasons. Some are too busy to manage their own financial lives, while others lack the expertise to do so and then there are those who have time and smarts, but just can’t stand the emotional ups and downs of the investment world. Regardless of which category the client falls in, the answer to what they usually want is abundantly clear: “I want to make sure that I am going to be OK!”
I know that this may sound simple, but indeed, this is exactly my experience with the folks that I see in my office and talk to on the radio, regardless of whether they have $200,000 or $2,000,000 to invest. Oh sure, the point of entry may begin with a concrete question, like “Am I using the right assets in my retirement account?”, “Which 529 plan should I use for my daughter’s college funds?”, “Do I need a revocable trust?” and of course, “Can you help me reduce my tax bill?” But any advisor worth his/her salt will use these questions as a jumping off point to gain a greater understanding of the overall needs of the person asking the questions. And the real questions underlying the first round usually are: can we retire comfortably? How much do we need to sock away to be able to retire sooner? How much can we spend during our retirement years?
The ultimate goal of a fiduciary advisor is to provide not just simple answers, but a more meaningful response. Despite how much money anyone has, he wants to feel confident that he will not run out of money and he will not need to endure too much market risk to reach his goals. In the end, most people want to gain peace of mind that the advisor who is assisting them in wealth management is going to help them get to a specific destination with a reduced level of anxiety. In the end, what the people in my industry meeting seemed to share was an acknowledgment that our job is not to “beat the market”, but to help our clients relax and help them navigate their larger financial issues. It’s a pretty good job!
Individuals choose to work with registered investment advisors for lots of different reasons. Some are too busy to manage their own financial lives, while others lack the expertise to do so and then there are those who have time and smarts, but just can’t stand the emotional ups and downs of the investment world. Regardless of which category the client falls in, the answer to what they usually want is abundantly clear: “I want to make sure that I am going to be OK!”
I know that this may sound simple, but indeed, this is exactly my experience with the folks that I see in my office and talk to on the radio, regardless of whether they have $200,000 or $2,000,000 to invest. Oh sure, the point of entry may begin with a concrete question, like “Am I using the right assets in my retirement account?”, “Which 529 plan should I use for my daughter’s college funds?”, “Do I need a revocable trust?” and of course, “Can you help me reduce my tax bill?” But any advisor worth his/her salt will use these questions as a jumping off point to gain a greater understanding of the overall needs of the person asking the questions. And the real questions underlying the first round usually are: can we retire comfortably? How much do we need to sock away to be able to retire sooner? How much can we spend during our retirement years?
The ultimate goal of a fiduciary advisor is to provide not just simple answers, but a more meaningful response. Despite how much money anyone has, he wants to feel confident that he will not run out of money and he will not need to endure too much market risk to reach his goals. In the end, most people want to gain peace of mind that the advisor who is assisting them in wealth management is going to help them get to a specific destination with a reduced level of anxiety. In the end, what the people in my industry meeting seemed to share was an acknowledgment that our job is not to “beat the market”, but to help our clients relax and help them navigate their larger financial issues. It’s a pretty good job!
Tuesday, November 13, 2007
I got sssssssteam heat…
As the price of crude oil nears $100, my thoughts wander to…a Broadway musical! This could be a stretch, but in “The Pajama Game” there is a song called “Steam Heat,” with an almost-perfect hook: “I got sssssssteam heat…But I need your love to keep away the cold!” As the winter months near, Northeasterners should be reminded of this song.
According to the Department of Energy, Northeastern states use 76% of the nation's heating oil and almost of a third of households in the region use oil heat. Unfortunately, the price for heating oil has risen about 2.5 times faster than for gasoline in recent weeks because heating oil and related products, such as diesel oil, are in record demand here and overseas. As a result, Northeasterners are facing a projected increase of over 20% for heating oil—ouch!
The spiking costs are the continuation of a multi-year trend: from ’00-05, the average cost in New England for a winter's supply of heating oil was $900 a household. Last year, it hit a record $1,433 and this year it could reach over $2,200. Given that we are all paying more to fill up our cars each week, it’s time to pull out the old sweater from Jimmy Carter’s “Whip Inflation Now” (WIN) and find ways to reduce your home heating bill.
1. Opt for a price cap: The way that you pay for oil could save you money. Fuel companies usually let you buy oil as you need it, but many give you an option to “lock in” a price or elect a “price cap,” which guarantees a per-gallon price that will not go higher over winter. Because the risk of rising prices is more significant than if prices drop, the capped price is one of the best ways to control your costs.
2. Install a programmable thermostat: This can save about $150 a year in energy costs if your home temperature is set back 8 degrees in the winter for an 8-hour span during the day when no one is home, and 10 hours at night. Cost: Less than $50
3. Do system maintenance: Contact your oil company or the company that installed your furnace or boiler to go over the system, which should cost $100-$150 but could save that amount and more for years to come!
4. Conduct an energy audit: You can hire an expert to conduct an "energy audit", or you can do it yourself. Go to the US EPA’s Energy Star Home Advisor web site (www.energystar.gov/homeadvisor) for tips that could help you reduce your energy bills by up to 25%. Enter your ZIP code and the type of heating, cooling system and water heater you have, and you will receive a customized list of recommendations — from caulking doorways to adding more insulation to the attic.
5. File for an energy tax credit: Replacing an old furnace, boiler, or water heater with energy-efficient units can save you money on your taxes, too. Installing new storm windows and insulation can also help keep your house warmer. Look for products with the ENERGY STAR logo. The EPA says they’re designed to use 10-50% less energy and water than standard models. File Form 5695, Residential Energy Credits, with your 2007 Federal Income Tax Return.
And on top of these ideas, the tried and true methods prescribed in “The Pajama Game” are probably a little more fun.
“But I can't get warm without your hand to hold.The radiators hissin’ still I need your kissin’ to keep me from freezing each nite.I've got a hot water bottle, but nothing I've got'll take the place of you holdin’ me tight.”
According to the Department of Energy, Northeastern states use 76% of the nation's heating oil and almost of a third of households in the region use oil heat. Unfortunately, the price for heating oil has risen about 2.5 times faster than for gasoline in recent weeks because heating oil and related products, such as diesel oil, are in record demand here and overseas. As a result, Northeasterners are facing a projected increase of over 20% for heating oil—ouch!
The spiking costs are the continuation of a multi-year trend: from ’00-05, the average cost in New England for a winter's supply of heating oil was $900 a household. Last year, it hit a record $1,433 and this year it could reach over $2,200. Given that we are all paying more to fill up our cars each week, it’s time to pull out the old sweater from Jimmy Carter’s “Whip Inflation Now” (WIN) and find ways to reduce your home heating bill.
1. Opt for a price cap: The way that you pay for oil could save you money. Fuel companies usually let you buy oil as you need it, but many give you an option to “lock in” a price or elect a “price cap,” which guarantees a per-gallon price that will not go higher over winter. Because the risk of rising prices is more significant than if prices drop, the capped price is one of the best ways to control your costs.
2. Install a programmable thermostat: This can save about $150 a year in energy costs if your home temperature is set back 8 degrees in the winter for an 8-hour span during the day when no one is home, and 10 hours at night. Cost: Less than $50
3. Do system maintenance: Contact your oil company or the company that installed your furnace or boiler to go over the system, which should cost $100-$150 but could save that amount and more for years to come!
4. Conduct an energy audit: You can hire an expert to conduct an "energy audit", or you can do it yourself. Go to the US EPA’s Energy Star Home Advisor web site (www.energystar.gov/homeadvisor) for tips that could help you reduce your energy bills by up to 25%. Enter your ZIP code and the type of heating, cooling system and water heater you have, and you will receive a customized list of recommendations — from caulking doorways to adding more insulation to the attic.
5. File for an energy tax credit: Replacing an old furnace, boiler, or water heater with energy-efficient units can save you money on your taxes, too. Installing new storm windows and insulation can also help keep your house warmer. Look for products with the ENERGY STAR logo. The EPA says they’re designed to use 10-50% less energy and water than standard models. File Form 5695, Residential Energy Credits, with your 2007 Federal Income Tax Return.
And on top of these ideas, the tried and true methods prescribed in “The Pajama Game” are probably a little more fun.
“But I can't get warm without your hand to hold.The radiators hissin’ still I need your kissin’ to keep me from freezing each nite.I've got a hot water bottle, but nothing I've got'll take the place of you holdin’ me tight.”
Monday, November 12, 2007
Engineering Portfolio Returns
Engineers are a special breed of investor—at least the engineers that I have seen in my career. These detail-oriented creatures show up at the office, armed with spreadsheets of cash flow, net worth and of course, portfolio allocation --- color pie charts at no extra charge! With all of their great knowledge of numbers and their organized minds, why do engineers need investment advice?
The answer to that question was revealed to me when “John,” a civil engineer, wanted to discuss his retirement accounts. I smiled as he unpacked what looked like a suitcase full of financial projections and balance sheets. After reviewing the numbers, I concurred with John’s belief that his goal of retiring in two years was indeed attainable. “That’s what I keep telling my wife, so I’m glad to hear it.”
I then pointed out that the only way that the 55-year old couple might run into a problem is if they incurred heavy losses in their portfolios at the wrong time, “so let’s take a look at how you are invested right now.” The first graph was an asset allocation pie chart that showed a fairly significant overweight in stocks. The total portfolio was 82% stocks, 12% bonds and 6% cash. That seemed a tad bit aggressive for a couple that wanted to retire in two years, but it wasn’t the biggest problem.
When I reviewed the holdings, I saw that of the total assets invested for retirement, 75% was in-the-money stock options of one company---the company for whom John worked! Of course John knew that this dangerous, but his problem was that his engineering brain was stuck in a loop. He kept trying to figure out how he could avoid taxes when he exercised and sold the position. And in the year that he has been trying to figure it out, the stock price has been rising, so it has not hurt him to drag his feet in the process.
While I think tax reduction is important for all investors, the risk that John was assuming so near to his desired retirement age seemed enormous. He said that when he thought about paying taxes, it felt like he was losing “40% of the gains”. I reminded him that at least 15-18% of the gains absolutely belonged to the federal and state governments. The remaining taxes due would be realized depending on the timing of the sale (whether the proceeds would be taxed at long or short-term rates). “The main question to consider is how you would feel if the stock went down and instead of paying 20 cents on the dollar in taxes, you would be eating 100 cents of every dollar as the stock dropped.”
John was stymied. He wanted to find a solution that would satisfy the need to diversify and to reduce taxes. Like so many others, he really wanted rewards without risk. Unfortunately in the emotional world of investing, this is usually impossible. No matter how hard we try, there is a tradeoff. Each individual must clearly understand and weigh both the risks and rewards involved in every investment decision to determine the most reasonable action necessary. Sometimes you can’t engineer the portfolio returns that you want, even when armed with information.
The answer to that question was revealed to me when “John,” a civil engineer, wanted to discuss his retirement accounts. I smiled as he unpacked what looked like a suitcase full of financial projections and balance sheets. After reviewing the numbers, I concurred with John’s belief that his goal of retiring in two years was indeed attainable. “That’s what I keep telling my wife, so I’m glad to hear it.”
I then pointed out that the only way that the 55-year old couple might run into a problem is if they incurred heavy losses in their portfolios at the wrong time, “so let’s take a look at how you are invested right now.” The first graph was an asset allocation pie chart that showed a fairly significant overweight in stocks. The total portfolio was 82% stocks, 12% bonds and 6% cash. That seemed a tad bit aggressive for a couple that wanted to retire in two years, but it wasn’t the biggest problem.
When I reviewed the holdings, I saw that of the total assets invested for retirement, 75% was in-the-money stock options of one company---the company for whom John worked! Of course John knew that this dangerous, but his problem was that his engineering brain was stuck in a loop. He kept trying to figure out how he could avoid taxes when he exercised and sold the position. And in the year that he has been trying to figure it out, the stock price has been rising, so it has not hurt him to drag his feet in the process.
While I think tax reduction is important for all investors, the risk that John was assuming so near to his desired retirement age seemed enormous. He said that when he thought about paying taxes, it felt like he was losing “40% of the gains”. I reminded him that at least 15-18% of the gains absolutely belonged to the federal and state governments. The remaining taxes due would be realized depending on the timing of the sale (whether the proceeds would be taxed at long or short-term rates). “The main question to consider is how you would feel if the stock went down and instead of paying 20 cents on the dollar in taxes, you would be eating 100 cents of every dollar as the stock dropped.”
John was stymied. He wanted to find a solution that would satisfy the need to diversify and to reduce taxes. Like so many others, he really wanted rewards without risk. Unfortunately in the emotional world of investing, this is usually impossible. No matter how hard we try, there is a tradeoff. Each individual must clearly understand and weigh both the risks and rewards involved in every investment decision to determine the most reasonable action necessary. Sometimes you can’t engineer the portfolio returns that you want, even when armed with information.
Friday, November 9, 2007
Lisa’s Lament
“Lisa” e-mailed the radio show about a month ago, asking what she should do about a portfolio heavily weighted in financial stocks (she estimated that about 40% of her $200,000 non-retirement portfolio was concentrated in the sector). While on the air, I responded, “I would cry!” but that was obviously not the last word on the topic.
I started to e-mail with Lisa to learn more about her situation. She noted, “I must say that your response of "CRY" to my question has been my gut reaction for the past couple of months.” She had been frustrated by her advisor, who “doesn’t seem to listen to me!” Lisa’s lament was one with which I am quite familiar and I asked her to come in to the office so that I could review the portfolio and provide her with guidance.
I learned that Lisa is retired and that the money that was in this account was probably invested more aggressively than it should have been, given her overall risk tolerance and potential need for the money within the next five years. That was the first problem. Problem #2 was that the portfolio was difficult to change (she wanted her advisor to sell all of the financial stocks in the portfolio), because it was managed by a sub-advisor in a pooled account, not by her investment advisor. Finally, the last problem was the fees associated with the account were high…really high.
After identifying the three problems, it was on to the fun part: the solutions! Lisa showed me the new proposal that her advisor had presented. I pointed out that the advisor was suggesting that Lisa switch to a balanced sub-advisor to replace the more growth-oriented sub-advisor that she had. I asked her a simple question: “if that’s his answer, then why not manage the account yourself?” She looked at me as if I had suggested that she jump into the space shuttle and fly to the moon, so I elaborated on the recommendation.
If her advisor thought that Lisa should be in a balanced portfolio of stocks and bonds, she might consider purchasing a Vanguard Balanced Index Fund (VBINX) directly. Instead of paying her manager 2.25%, she would pay Vanguard .20% -- a savings of $4,100 annually! She wondered if the performance might be better over time with the sub-advisor, but it would have to be a whole heck of lot better to justify 2.05% every single year!
It seemed like a great solution to me, but Lisa said that she did not want to deal with managing her money herself and in fact, for some odd reason, despite her admission that she did not think her advisor was all that smart when it came to investments, “he does meet with me every month and help me reallocate my variable annuities.” Oi, variable annuities too? In the end, despite Lisa’s lament, I just didn’t think that she was ready to make a big change. I sent her on her way, telling her as much. She sent me an e-mail a few hours later thanking me for my time and said, “Who knows? You may not have heard the last of me yet.”
I started to e-mail with Lisa to learn more about her situation. She noted, “I must say that your response of "CRY" to my question has been my gut reaction for the past couple of months.” She had been frustrated by her advisor, who “doesn’t seem to listen to me!” Lisa’s lament was one with which I am quite familiar and I asked her to come in to the office so that I could review the portfolio and provide her with guidance.
I learned that Lisa is retired and that the money that was in this account was probably invested more aggressively than it should have been, given her overall risk tolerance and potential need for the money within the next five years. That was the first problem. Problem #2 was that the portfolio was difficult to change (she wanted her advisor to sell all of the financial stocks in the portfolio), because it was managed by a sub-advisor in a pooled account, not by her investment advisor. Finally, the last problem was the fees associated with the account were high…really high.
After identifying the three problems, it was on to the fun part: the solutions! Lisa showed me the new proposal that her advisor had presented. I pointed out that the advisor was suggesting that Lisa switch to a balanced sub-advisor to replace the more growth-oriented sub-advisor that she had. I asked her a simple question: “if that’s his answer, then why not manage the account yourself?” She looked at me as if I had suggested that she jump into the space shuttle and fly to the moon, so I elaborated on the recommendation.
If her advisor thought that Lisa should be in a balanced portfolio of stocks and bonds, she might consider purchasing a Vanguard Balanced Index Fund (VBINX) directly. Instead of paying her manager 2.25%, she would pay Vanguard .20% -- a savings of $4,100 annually! She wondered if the performance might be better over time with the sub-advisor, but it would have to be a whole heck of lot better to justify 2.05% every single year!
It seemed like a great solution to me, but Lisa said that she did not want to deal with managing her money herself and in fact, for some odd reason, despite her admission that she did not think her advisor was all that smart when it came to investments, “he does meet with me every month and help me reallocate my variable annuities.” Oi, variable annuities too? In the end, despite Lisa’s lament, I just didn’t think that she was ready to make a big change. I sent her on her way, telling her as much. She sent me an e-mail a few hours later thanking me for my time and said, “Who knows? You may not have heard the last of me yet.”
Thursday, November 8, 2007
A Chill in the Air (Don’t Worry, Chillax!)
I woke up yesterday morning and for the first time, grabbed a scarf before heading out into a crisp New England morning. There was a real chill in the air and I guessed that I would need to wrap myself in a cocoon of warmth. As the day progressed, it was clear that a cool blast was sweeping through Wall Street and by the end of the day investors would need to seek comfort in their respective scarves.
Like a new season that you know is coming, but still catches you by surprise, yesterday’s market action was painful, though not shocking. We had been feeling the cool winds over the past couple of weeks, in the form of more bad news from financial institutions about subprime losses. Although we were warned of the new weather pattern, now that it is here, investors are feeling chilled to their bones.
As banks attempt to quantify the billions of dollars of losses tied to mortgage-related securities, there were hints of more credit headaches yesterday. Stocks started the day weak, but selling accelerated around midday, and major benchmarks finished near their lows for the session. The Dow Jones Industrial Average tumbled 360.92 points to 13300.02, wiping out all the gains since the Fed's first rate cut September 18. The S&P 500 sagged 44.65 points to 1475.62, while the Nasdaq Composite Index shed 76.42 points to slide to 2748.76.
And like the weather professionals who can’t help talk about the first chill or snow storm, the analysts were coming out of the woodworks to do the play-by-play of this event. Ratings agency Moody's downgraded about $36 billion of debt securities held in structured investment vehicles (if you’re like me, you might be wondering where the ratings agencies were when we needed them—when the initial ratings were determined for these securities!) and others were guesstimating that when the dust settles from this credit crisis, there will be over $100 billion in write-downs on the illiquid, difficult-to-value holdings.
Before you get crazy about the weather (what are we, Brits?), don’t forget that you probably have a delicious scarf in your investment closet---it maybe those “boring” short-term government bonds or the classic black cashmere, also known as the money market account, or maybe the exotic and colorful commodities position. Any of these might provide some comfort as everyone else is frozen with fear. In the words of my nephew, this is not an occasion to be chilled by fear; rather diversified investors can “chillax”.
Like a new season that you know is coming, but still catches you by surprise, yesterday’s market action was painful, though not shocking. We had been feeling the cool winds over the past couple of weeks, in the form of more bad news from financial institutions about subprime losses. Although we were warned of the new weather pattern, now that it is here, investors are feeling chilled to their bones.
As banks attempt to quantify the billions of dollars of losses tied to mortgage-related securities, there were hints of more credit headaches yesterday. Stocks started the day weak, but selling accelerated around midday, and major benchmarks finished near their lows for the session. The Dow Jones Industrial Average tumbled 360.92 points to 13300.02, wiping out all the gains since the Fed's first rate cut September 18. The S&P 500 sagged 44.65 points to 1475.62, while the Nasdaq Composite Index shed 76.42 points to slide to 2748.76.
And like the weather professionals who can’t help talk about the first chill or snow storm, the analysts were coming out of the woodworks to do the play-by-play of this event. Ratings agency Moody's downgraded about $36 billion of debt securities held in structured investment vehicles (if you’re like me, you might be wondering where the ratings agencies were when we needed them—when the initial ratings were determined for these securities!) and others were guesstimating that when the dust settles from this credit crisis, there will be over $100 billion in write-downs on the illiquid, difficult-to-value holdings.
Before you get crazy about the weather (what are we, Brits?), don’t forget that you probably have a delicious scarf in your investment closet---it maybe those “boring” short-term government bonds or the classic black cashmere, also known as the money market account, or maybe the exotic and colorful commodities position. Any of these might provide some comfort as everyone else is frozen with fear. In the words of my nephew, this is not an occasion to be chilled by fear; rather diversified investors can “chillax”.
Wednesday, November 7, 2007
Two Economies
I was discussing the US economy with my client “Eric” yesterday. He noted that many of the Democratic presidential candidates are talking about “two economies,” but that he does not see evidence of that fact. Given that Eric is a corporate attorney who earns approximately $400,000 per year, this does not surprise me. But I talk to all kinds of people on the radio every weekend and I have heard and experienced the voices of the two different economies. Without turning this into a political column, let’s discuss some of the facts.
According to IRS data released last month, the wealthiest 1% of Americans earned 21.2% of all income in 2005, which is up sharply from 19% in 2004, and surpasses the previous high of 20.8% set in 2000, at the peak of the previous bull market in stocks. The bottom 50% earned 12.8% of all income, down from 13.4% in 2004 and a bit less than their 13% share in 2000. These numbers are based on a large sample of tax returns and reflect "adjusted gross income," which is income after some deductions, such as for alimony and contributions to individual retirement accounts.
How did this happen? Economists and scholars attribute rising inequality to several factors, including technological change that favors those with more skills, but I think that it also speaks to globalization, which has forced down wages in some sectors of the US economy. Indeed, there has been a divergence between who is benefiting from globalization in the developed world. In these early stages, it appears that those who already own capital are making great strides, while only meager rewards are going to labor. In other words, the rich may be getting richer and living better, while the middle is somewhat stuck.
That’s why despite strong growth in the US economy last quarter (estimated at 3.9%), many Americans think the economy is in a recession. Remember, a recession is defined as two consecutive quarters of negative growth and we are clearly far from that level. But some people feel worse than the data indicate, despite news that the US economy is doing well and we are all living better as a result of the forces of globalization. It is obvious that the economic strength of certain sectors or the stock market does not negate the fact that if you work in the auto industry, the economy probably seems miserable. Or if you have had to pay more for your health insurance or have given up a piece of your pension because of changes in the economy, you probably had to make significant adjustments to your lifestyle and Democratic candidates are attempting to exploit those feelings every day on the campaign trail.
People like Eric may not encounter the other tier of the economy on a day-to-day basis, but I believe that it really does exist. The proof may be as simple as these numbers: the IRS data show that the median tax filer's income -- half earn less than the median, half earn more -- fell 2% between 2000 and 2005 when adjusted for inflation, to $30,881. At the same time, the income level for the tax filer just inside the top 1% grew 3%, to $364,657. That sounds like two-tiers to me.
According to IRS data released last month, the wealthiest 1% of Americans earned 21.2% of all income in 2005, which is up sharply from 19% in 2004, and surpasses the previous high of 20.8% set in 2000, at the peak of the previous bull market in stocks. The bottom 50% earned 12.8% of all income, down from 13.4% in 2004 and a bit less than their 13% share in 2000. These numbers are based on a large sample of tax returns and reflect "adjusted gross income," which is income after some deductions, such as for alimony and contributions to individual retirement accounts.
How did this happen? Economists and scholars attribute rising inequality to several factors, including technological change that favors those with more skills, but I think that it also speaks to globalization, which has forced down wages in some sectors of the US economy. Indeed, there has been a divergence between who is benefiting from globalization in the developed world. In these early stages, it appears that those who already own capital are making great strides, while only meager rewards are going to labor. In other words, the rich may be getting richer and living better, while the middle is somewhat stuck.
That’s why despite strong growth in the US economy last quarter (estimated at 3.9%), many Americans think the economy is in a recession. Remember, a recession is defined as two consecutive quarters of negative growth and we are clearly far from that level. But some people feel worse than the data indicate, despite news that the US economy is doing well and we are all living better as a result of the forces of globalization. It is obvious that the economic strength of certain sectors or the stock market does not negate the fact that if you work in the auto industry, the economy probably seems miserable. Or if you have had to pay more for your health insurance or have given up a piece of your pension because of changes in the economy, you probably had to make significant adjustments to your lifestyle and Democratic candidates are attempting to exploit those feelings every day on the campaign trail.
People like Eric may not encounter the other tier of the economy on a day-to-day basis, but I believe that it really does exist. The proof may be as simple as these numbers: the IRS data show that the median tax filer's income -- half earn less than the median, half earn more -- fell 2% between 2000 and 2005 when adjusted for inflation, to $30,881. At the same time, the income level for the tax filer just inside the top 1% grew 3%, to $364,657. That sounds like two-tiers to me.
Tuesday, November 6, 2007
What does this have to do with ME?
My Muse likes to remind me that most of the things that occur in the financial world should boil down to one question: What does this have to do with ME? To that end, I want to answer that question as it pertains to the evolving story of Merrill Lynch, Citigroup and the credit crunch.
You may have heard that two CEOs are out of jobs -- E. Stanley O’Neal of Merrill Lynch and Charles Prince III of Citigroup. They both got canned because under their helms, their respective companies lost a boatload of money in mortgage-related securities. To better understand the ripple effects of this mess and what it’s got to do with you, we need to review what has happened.
For a long period of time, the Fed left interest rates low, which encouraged lots of people to borrow. Some bought houses or condos, while others refinanced and spent the proceeds on new kitchens. This period was highlighted by the expansion of lending parameters to include those who had previously had a difficult time acquiring mortgages, or so-called “subprime” (those with low credit scores) and “Alt-A” borrowers (those who attained mortgages without having to support their income and asset levels with the normal documentation).
The Wizards of Wall Street professionals created new ways to put cheap money to work and earn more than the cost of money borrowed. They created complex packages of mortgages or financial instruments based on mortgages, which they erroneously believed would help defray the risk of the risky loans. When housing prices were rising and interest rates remained low, everything was fine. But as the housing market dipped, the ability of some of the borrowers to repay their loans changed, causing delinquencies and defaults.
As soon as investors realized that there were significant problems with the loan repayments, it raised questions about the value of mortgage-backed securities and the credibility of the ratings that enabled the securities to be sold. As investors were spooked by the uncertainty about where credit losses were hidden, the lending business simply stopped, making it more difficult for companies and individuals to borrow. Additionally, for the companies holding the loans or the securities that were collateralized (backed up) by the loans, there was no stock exchange to determine value. Therefore, the companies kind of guessed about how much they were losing. As the real numbers have come in, the true losses were worse than expected, which caused 2 guys (so far) to get axed.
Now that you have the back story, here is why two super-rich, Wall Street execs losing their jobs actually might have something to do with you:
1) If you need to borrow money, the rules have changed. My friend Mike Raimi, President of WCS Lending, tells me that lenders are practically asking for DNA to qualify borrowers. If your credit is even a shade sketchy, it is very difficult to secure a loan. However, if you have sterling credit and you are applying for a conventional, not a jumbo loan (less than $417,000) there should not be a big problem.
2) The ability to borrow is like lubricant to the US economy. When it becomes more difficult for individuals and companies to borrow, it could stall business and consumer spending, potentially leading to a recession. The “R” word is never good for anyone, nor is it good for any asset class.
3) If you are an investor, markets are gyrating hourly on this news. This volatility can sometimes spook investors, but the main thing to remember is that being an investor of any type requires the ability to withstand ups and downs from time-to-time in order to enjoy the periods of rising asset values. Chances are, if you have a diversified portfolio, you should be able to weather the swings without fear or panic and instead you can approach volatile markets as a time to seize potential opportunities. If that is not the case, you have a strong indication that your allocation is out of whack with your risk tolerance.
You may have heard that two CEOs are out of jobs -- E. Stanley O’Neal of Merrill Lynch and Charles Prince III of Citigroup. They both got canned because under their helms, their respective companies lost a boatload of money in mortgage-related securities. To better understand the ripple effects of this mess and what it’s got to do with you, we need to review what has happened.
For a long period of time, the Fed left interest rates low, which encouraged lots of people to borrow. Some bought houses or condos, while others refinanced and spent the proceeds on new kitchens. This period was highlighted by the expansion of lending parameters to include those who had previously had a difficult time acquiring mortgages, or so-called “subprime” (those with low credit scores) and “Alt-A” borrowers (those who attained mortgages without having to support their income and asset levels with the normal documentation).
The Wizards of Wall Street professionals created new ways to put cheap money to work and earn more than the cost of money borrowed. They created complex packages of mortgages or financial instruments based on mortgages, which they erroneously believed would help defray the risk of the risky loans. When housing prices were rising and interest rates remained low, everything was fine. But as the housing market dipped, the ability of some of the borrowers to repay their loans changed, causing delinquencies and defaults.
As soon as investors realized that there were significant problems with the loan repayments, it raised questions about the value of mortgage-backed securities and the credibility of the ratings that enabled the securities to be sold. As investors were spooked by the uncertainty about where credit losses were hidden, the lending business simply stopped, making it more difficult for companies and individuals to borrow. Additionally, for the companies holding the loans or the securities that were collateralized (backed up) by the loans, there was no stock exchange to determine value. Therefore, the companies kind of guessed about how much they were losing. As the real numbers have come in, the true losses were worse than expected, which caused 2 guys (so far) to get axed.
Now that you have the back story, here is why two super-rich, Wall Street execs losing their jobs actually might have something to do with you:
1) If you need to borrow money, the rules have changed. My friend Mike Raimi, President of WCS Lending, tells me that lenders are practically asking for DNA to qualify borrowers. If your credit is even a shade sketchy, it is very difficult to secure a loan. However, if you have sterling credit and you are applying for a conventional, not a jumbo loan (less than $417,000) there should not be a big problem.
2) The ability to borrow is like lubricant to the US economy. When it becomes more difficult for individuals and companies to borrow, it could stall business and consumer spending, potentially leading to a recession. The “R” word is never good for anyone, nor is it good for any asset class.
3) If you are an investor, markets are gyrating hourly on this news. This volatility can sometimes spook investors, but the main thing to remember is that being an investor of any type requires the ability to withstand ups and downs from time-to-time in order to enjoy the periods of rising asset values. Chances are, if you have a diversified portfolio, you should be able to weather the swings without fear or panic and instead you can approach volatile markets as a time to seize potential opportunities. If that is not the case, you have a strong indication that your allocation is out of whack with your risk tolerance.
Monday, November 5, 2007
Mother Merrill and You
My girlfriend who works at one of the big Wall Street firms asked, “Do you think people who are not in this industry really care about the Merrill Lynch story?” I thought the same thing after appearing as a guest on the new Fox Business Network last week.
The hosts, Liz Claman, formerly of CNBC and David Asman, who moved to FBN from Fox News Channel, started the conversation with a discussion of Merrill Lynch’s impending (now already-announced) firing of Chairman and CEO E. Stanley O’Neal. While the chatter focused on the ins and outs of why the board let him go (tops on the list of reasons was the $8.4 billion write-down due to losses associated with the sub-prime debacle), I could not help thinking: what can the rest of us take away from this situation?
Unfortunately, I did not think about this during the interview, so I have saved it for an article. I think the most interesting part of the story is that O’Neal and his Board fell for the oldest trap in the investment book: they piled into a strategy long after it had seen its heyday and ignored the risks that were associated with big gains.
O’Neal sought ways to improve the earnings of the somewhat stogy firm, which led him to enter the murky subprime/collateralized debt obligation (CDO) market. The board liked the results when the trades were winners--it’s like the guy who bragged to me about the money he made after purchasing technology stocks in the beginning of 1999. The whole year I had to hear from him on the radio show. By the spring of 2000, the tech bubble started to collapse and all of the sudden the calls stopped.
Liz Claman noted that since O’Neal took the helm of Merrill, the stock had increased 60%. But investors and boards have very narrow time horizons when it comes to accepting the pain of losing. Since the beginning of 2006 through October 30, Merrill’s stock price had declined just under 1%. Obviously the broader market was up during the same time and some of Merrill’s rivals, including Goldman Sachs, Morgan Stanley and JP Morgan Chase have enjoyed returns of 91%, 43.5% and 24.7% respectively over the almost two-year period.
When the news of the losses exceeded $8 billion, O’Neal stood up and delivered the grim details. In fact, he is one of the few Wall Street CEOs who took personal responsibility for losing money. There was no blaming a rogue trader or a flawed computer model, just one man, saying publicly, “I’m responsible”.
I’m less impressed with Merrill’s board. Sure, they held O’Neal accountable and fired him (his exit compensation is valued at about $161.5 million), but only when the strategy went awry did they not like the risks that had been assumed. In my mind, the questioning should have taken place not after the losses had occurred, but when the firm was earning record profits in the exotic debt market. A board member might have asked O’Neal and his team to quantify the risks inherent in the strategies, because as every investor knows, rarely do we get the rewards without risks.
So what can you learn from Merrill? Beware the temptations that draw you into a new strategy and of course, mind the risks that may deliver outsized returns and losses at any given time.
The hosts, Liz Claman, formerly of CNBC and David Asman, who moved to FBN from Fox News Channel, started the conversation with a discussion of Merrill Lynch’s impending (now already-announced) firing of Chairman and CEO E. Stanley O’Neal. While the chatter focused on the ins and outs of why the board let him go (tops on the list of reasons was the $8.4 billion write-down due to losses associated with the sub-prime debacle), I could not help thinking: what can the rest of us take away from this situation?
Unfortunately, I did not think about this during the interview, so I have saved it for an article. I think the most interesting part of the story is that O’Neal and his Board fell for the oldest trap in the investment book: they piled into a strategy long after it had seen its heyday and ignored the risks that were associated with big gains.
O’Neal sought ways to improve the earnings of the somewhat stogy firm, which led him to enter the murky subprime/collateralized debt obligation (CDO) market. The board liked the results when the trades were winners--it’s like the guy who bragged to me about the money he made after purchasing technology stocks in the beginning of 1999. The whole year I had to hear from him on the radio show. By the spring of 2000, the tech bubble started to collapse and all of the sudden the calls stopped.
Liz Claman noted that since O’Neal took the helm of Merrill, the stock had increased 60%. But investors and boards have very narrow time horizons when it comes to accepting the pain of losing. Since the beginning of 2006 through October 30, Merrill’s stock price had declined just under 1%. Obviously the broader market was up during the same time and some of Merrill’s rivals, including Goldman Sachs, Morgan Stanley and JP Morgan Chase have enjoyed returns of 91%, 43.5% and 24.7% respectively over the almost two-year period.
When the news of the losses exceeded $8 billion, O’Neal stood up and delivered the grim details. In fact, he is one of the few Wall Street CEOs who took personal responsibility for losing money. There was no blaming a rogue trader or a flawed computer model, just one man, saying publicly, “I’m responsible”.
I’m less impressed with Merrill’s board. Sure, they held O’Neal accountable and fired him (his exit compensation is valued at about $161.5 million), but only when the strategy went awry did they not like the risks that had been assumed. In my mind, the questioning should have taken place not after the losses had occurred, but when the firm was earning record profits in the exotic debt market. A board member might have asked O’Neal and his team to quantify the risks inherent in the strategies, because as every investor knows, rarely do we get the rewards without risks.
So what can you learn from Merrill? Beware the temptations that draw you into a new strategy and of course, mind the risks that may deliver outsized returns and losses at any given time.
Friday, November 2, 2007
Rooting for the Down Days
What is it about a plunging market that puts me into such a good mood? Maybe it’s a throwback to the old options trader in me—you know, with volatility, especially on the downside, comes opportunity; and with opportunity, comes money-making potential! I have found that some of my best trades have occurred when everyone around me is panicking, so why not root for a little anxiety attack every now and again?
Perhaps you were busy re-reading War and Peace yesterday, so let me recap what happened. A day after stocks rallied on the heels of a Federal Reserve quarter-point interest rate cut, investors sold off stocks in a big way. Yes, there was a downgrade of Citigroup and below-forecast earnings from Exxon Mobil, but I think that the essence of the sell-off was investors worrying that maybe the Fed would not keep cutting rates as expected. All three major indexes lost more than 2% of their value, with selling accelerating late in the day. The Dow Jones Industrial Average fell 362.14, or 2.6%, to 13567.87; the S&P 500 fell 40.94, or 2.6%, to 1508.44; and the NASDAQ fell 64.29, or 2.3%, to 2794.83.
There is no positive spin on the day—it was pretty rotten. Except if you’re like me and can convert those sour lemons into tasty lemonade. Of course, you can only take advantage of market gyrations if you have cash on hand. That’s why when people ask why they should allocate any of their money in the money market fund in their retirement accounts; I respond “you never know when you are going to want to do something!”
If you are always fully invested or mostly invested in risk assets, when the market moves, you can’t do anything but watch and pray that your positions don’t get beat up too much. I have always believed that a nice tidy pillow of cash, augmented by the warm blanket of government bonds, can cushion downward moves perfectly. Maybe you won’t even make a trade, but sometimes that cash/bond position is just enough to remind you that panic is for the other suckers, not for you, Mr/Mrs/Ms Diversified Investor!
What do you lose by employing a diversified approach to investing? The only thing you don’t get is bragging rights. When the market rises, you will not see your portfolio increase by the same margin as the overall market. Then again, when the tears are flowing as the market gets crushed, you can calmly assess the situation and determine if any action is warranted. At the very least, you’ll have many more good nights of sleep, so come on and root for the down days—you’ll see how freeing it is!
Perhaps you were busy re-reading War and Peace yesterday, so let me recap what happened. A day after stocks rallied on the heels of a Federal Reserve quarter-point interest rate cut, investors sold off stocks in a big way. Yes, there was a downgrade of Citigroup and below-forecast earnings from Exxon Mobil, but I think that the essence of the sell-off was investors worrying that maybe the Fed would not keep cutting rates as expected. All three major indexes lost more than 2% of their value, with selling accelerating late in the day. The Dow Jones Industrial Average fell 362.14, or 2.6%, to 13567.87; the S&P 500 fell 40.94, or 2.6%, to 1508.44; and the NASDAQ fell 64.29, or 2.3%, to 2794.83.
There is no positive spin on the day—it was pretty rotten. Except if you’re like me and can convert those sour lemons into tasty lemonade. Of course, you can only take advantage of market gyrations if you have cash on hand. That’s why when people ask why they should allocate any of their money in the money market fund in their retirement accounts; I respond “you never know when you are going to want to do something!”
If you are always fully invested or mostly invested in risk assets, when the market moves, you can’t do anything but watch and pray that your positions don’t get beat up too much. I have always believed that a nice tidy pillow of cash, augmented by the warm blanket of government bonds, can cushion downward moves perfectly. Maybe you won’t even make a trade, but sometimes that cash/bond position is just enough to remind you that panic is for the other suckers, not for you, Mr/Mrs/Ms Diversified Investor!
What do you lose by employing a diversified approach to investing? The only thing you don’t get is bragging rights. When the market rises, you will not see your portfolio increase by the same margin as the overall market. Then again, when the tears are flowing as the market gets crushed, you can calmly assess the situation and determine if any action is warranted. At the very least, you’ll have many more good nights of sleep, so come on and root for the down days—you’ll see how freeing it is!
Thursday, November 1, 2007
Are they going too far?
In an effort to "forestall some of the adverse effects on the broader economy that might otherwise arise" from the summer credit crunch, the Federal Reserve cut its target for short-term interest rates a quarter of a percentage point to 4.5% yesterday. This action comes six weeks after the Fed’s ½ point cut in September.
While the cut was anticipated, the accompanying statement was a bit more surprising. In an apparent attempt to rein in market expectations of further action, the statement noted that the Fed now sees the risks of weaker growth and higher inflation as "roughly [in] balance." Almost immediately, stocks and bonds sold off, as investors pondered the idea that perhaps Ben Bernanke’s Fed would not serve up a series of reflationary rate cuts. But then cooler heads prevailed and stocks closed on the highs of the session. It is Bernanke, after all, and the housing market is in the can, so that statement seemed more like a warning with a wink: “don’t count on us, but don’t worry, we’ll be there for you.”
The more interesting action was taking place in the commodities pits, where crude oil touched a record-high $94.74 after an Energy Department report showed that U.S. inventories fell to a two-year low. Dec crude finished the day up $4.15 or 4.6% at $94.53, which makes October’s gain a staggering 16%! For those history buffs, we have just over $7 before we reach the April, 1980, inflation-adjusted record of $101.70. Additionally, Dec gold added $7.50 to $795.30.
After examining those results, one might take away a bit of concern over inflation gurgling up. Before we get into one of those nutty arguments about how inflation is measured, let’s agree that the CPI is not perfect. That said, although raw materials prices have been on the move for five years or so, we have not experienced a huge impact on finished goods prices—that’s one of the many wonders of globalization. It would take far more price-push for core inflation to become a problem. Indeed, the CPI has been coming down from its cycle high 4.7% in September 2005 to the recent approximate 2% level.
As I noted yesterday, weaker US growth caused by a continued housing recession should increase economic slack and thus compress pricing power even further. This effect should translate into low core inflation, which is why I don’t think that the Fed has gone too far—at least not yet!
While the cut was anticipated, the accompanying statement was a bit more surprising. In an apparent attempt to rein in market expectations of further action, the statement noted that the Fed now sees the risks of weaker growth and higher inflation as "roughly [in] balance." Almost immediately, stocks and bonds sold off, as investors pondered the idea that perhaps Ben Bernanke’s Fed would not serve up a series of reflationary rate cuts. But then cooler heads prevailed and stocks closed on the highs of the session. It is Bernanke, after all, and the housing market is in the can, so that statement seemed more like a warning with a wink: “don’t count on us, but don’t worry, we’ll be there for you.”
The more interesting action was taking place in the commodities pits, where crude oil touched a record-high $94.74 after an Energy Department report showed that U.S. inventories fell to a two-year low. Dec crude finished the day up $4.15 or 4.6% at $94.53, which makes October’s gain a staggering 16%! For those history buffs, we have just over $7 before we reach the April, 1980, inflation-adjusted record of $101.70. Additionally, Dec gold added $7.50 to $795.30.
After examining those results, one might take away a bit of concern over inflation gurgling up. Before we get into one of those nutty arguments about how inflation is measured, let’s agree that the CPI is not perfect. That said, although raw materials prices have been on the move for five years or so, we have not experienced a huge impact on finished goods prices—that’s one of the many wonders of globalization. It would take far more price-push for core inflation to become a problem. Indeed, the CPI has been coming down from its cycle high 4.7% in September 2005 to the recent approximate 2% level.
As I noted yesterday, weaker US growth caused by a continued housing recession should increase economic slack and thus compress pricing power even further. This effect should translate into low core inflation, which is why I don’t think that the Fed has gone too far—at least not yet!
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